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Inflation and the ineffectiveness of Monetary Policy
Robert E. Lucas
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The
dogmatic
belief that easy money policy with low interest rates could boost
economic growth is increasingly being questioned. Ever more empirical
evidence in deed point at total ineffectiveness of monetary
policy. Two decades of close to zero interest rates in Japan and
Switserland for instance have been totally inadequate to give any
stimulus to
their
sluggish growth.
Nobel-prize
winners Friedman (1976), Lucas
(1995), and Phelps (2006) all expressed their doubts about the effectiveness of
loose money policy as means of boosting the economy. The
severest critique on central banking effectiveness, and also the most
systematic research into the matter has come from Robert E. LUCAS. In his
comprehensive study which yielded him the 1995 Nobel Prize he could
find no significant relation between growth of the
money supply and growth of the real economy. For Lucas, the only
significant effect of
increasing the money supply is increasing inflation, which obviously
slows down growth in the long run. So any attempt to boost growth
through reducing interest rates is therefore counterproductive.
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Lucas: More Money
means higher Inflation, not more Growth
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 Very remarkable also are
most recent (2006) empirical findings
by ' Prof. J-P. Chevallier of the
university of Nice (France). Chevallier found that "Excess Money Supply"
(EMS: Growth of the Money
Supply M3 in
excess of the growth rate of the real economy) has a remarkable
inverse relation to the real economy's growth rate. High EMS coincides
with low growth. Chevallier's study is based on over 550 data pairs
covering 47 years of US monetary history from 1960 till 2006. The
inverse course of both variables in the figure below is indeed too
remarkable to be coincidental.
Do we really need central Bankers?
Other studies go as far as questioning the
very reasons for the existence of Central Banks altogether. Prof. Hanke
for instance found that the average economic growth rate in countries
without central banks is 2.1 times higher than in those with central
banks. Countries without entral banks also have lower inflation. So the
main result of all the Central Banks actions is increased inflation. (
Source: Charles Oliver, "IMF
Again Comes Under Fire: Does it Really Need to Exist?" )
INFLATION: Diluting
workers' and savers' Buying Power
ECB Building Frankfurt.
Another superfluous institution ?
European
Monetary
System
or Excessive Money Suppliers ?
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Inflation
is a stealthy robbery, diverting resources from productive investment
and therefor slowing down the economy. Money can indeed only maintain
its buying power when an increase in the money supply is matched by an
equivalent increase of the supply of real goods and services. Central
Banks often set interest rates at artificially low levels supposedly to
stimulate growth. These low interest rates cause demand for loans to
increase excessively and the money supply to expand at a faster rate
than the real economy. This results in fast growing amounts of money
chasing slowly growing quantities of goods causing the price levels to
rise.
Robbery:
Inflationary money such as bankers create from thin air
obviously does not increase wealth of a nation nor its real buying
power, as their increase of the money supply is not accompanied by an
increase of real goods or services. The nominal buying power such money
provides to borrowers is merely diluted buying power, diluted from the
real buying power of someone else. It is indeed buying power stealthy
robbed from people having earned theirs through hard labour or in
exchange for real goods and services. Obviously the stealthy
devaluation of peoples' labour and savings progressively discourages
the producers of real wealth. Eventually they tend to reduce their
productive contribution, resulting in slowdown of growth; just the
opposite easy money was set up to do. |
 So
contrary popular belief and to bankers' claims, easy-money
policy can
never cause real growth, but merely creates a nominal
illusion of
progress. In the end real wealth can only be increased through
increasing the availability of real goods and services, and the only
way to increase production of tangible services and commodities is by
working more or by producing more effeciently. And productivity can
only be improved to a substantial extend through investment in better
machines, superior techniques or improved infrastructure. So a policy
aiming real growth must therefor promote saving and investment, and
certainly should not stimulate consumption. Easy money does the
opposite: it promotes consumption, discourages saving, penalises
investment and productive contribution, in the long run all slowing
down real growth; exactly the opposite it was set up to do.
INFLATION : diverting productive Resources
to Consumption
ECB
president Jean-Claude Trichet can't hide a Mona-Lisa smile while he is
stealthly diluting the worker's and saver's buying power.
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Artificially low interest rates merely
enlarge borrowing
margins. They do not increase earnings or possession. This easy access
to loans therefor merely creates an illusion of wealth tempting
borrowers into unsustainable debt. It is this illusion which
temporarily causes an artificial excess of demand over supply,
temporarily making everything saleable. Easy loans make expensive
consumer goods suddenly appear affordable. Outdated real estate turn
into desirable investment projects, and so do business concepts with
low retrurns whose life-cycle has since long gone by. Low interest
rates and excessive money supply consequently cause asset prices tot
rise. As a consequence ever more buying power gets immobilised for far
too long in outdated and low-return projects or in shares of outdated
businesses. |
Postponing
Renovation and creative Destruction
By doing so, easy money policy diverts
resources from productive
investment, ultimately slowing down technological evolution,
productivity gains and progress. Real estate in the end gets so
expensive that house rent absorbs much of people's earnings, and
acquiring a family house engages lifetime savings. The most devastating
effect of easy-money however is that by penalising saving, easy money
stimulates over-consumption, and slows down capital formation;
ultimately the indispensable resource of all technological progress.
(*) Read the whole story in: the book
below
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Abstract: While the rest of the
world is booming, Europe lags
behind. Europe's performance is
weak in
spite of high productivity and knowledge, high level of
development and good labour ethics. Growth is also remarkably
dissimular among regions. France, Germany and Italy are stagnating, and
so do Denmark,
Sweden and Finland. All gained less than 44%
prosperity over the last 20 years. The Irish
economy grew 4 times faster, gaining 169%
wealth over the same period. In half a generation Ireland so
metamorphosed into Europe's second
richest country creating jobs for all.
"
Big government
" is the main cause of Europe's weak performance. The oversized Public-Sector lacks productivity and undoes the
entire productivity gains of the Private Sector, eradicating
all of its outstanding performance and
productiveness. Europe can improve its overall performance by copying
the Irish
success formulas: Scaling down Public Spending, downsizing
bureaucracy, and shifting the tax burden
from
income on
consumption. This book demonstrates why the Lisbon
Agenda and decades of Keynesian inflationist demand stimulation have
failed. It devellops alternative and workable
supply-side strategies as well as effective cures for humane growth
and a financially
sustainable social security.
This
book reads as a step-by-step manual for economic
recovery.
It is a data-reference for students and politicians
interested in growth, wellfare and in social modelling. It is a
classic
for economists concerned about Big
Government, poor public sector productivity and for parents worrying
about their declining standard of living and their children's future.
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Dr.
Martin De Vlieghere is economist and doctor of philosophy since
1993. His PhD was written on the conditions of modernity in the
works of Habermas and Hayek. He has been assistant professor at the
Department of Philosophy of the University of Ghent. He is president of
the "Free Association for Civilization Studies" and member of the board
of directors of Nova Civitas.
Paul
Vreymans is econometrist and advisor at the Free Institute for
Economic Research. As an international businessman he is a close
witness of Europe's industrial collapse and the rise of the parasitical
bureaucratic complex. He is a founding member of the Brussels' think
tank WorkForAll.
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