By their nature, central banks are pretty conservative places. They prefer to operate in the shadows of the banks, pushing or pulling cash into or out of the financial system, and relying on bankers to to pass that money along to consumers and business through loans. Usually that works.
But as the fallout from the financial crisis has shown, banks that just barely survive being reduced to rubble aren’t usually in the mood to jump start lending. And for good reason, following financial crises, the economy is often in tatters, which makes lending to small businesses or homeowners look risky. As a result, bank lending continues to be weak. It’s like a kink in a garden hose: The liquidity doesn’t flow.
In his Financial Times column today, Martin Wolf argues that if the hose is blocked, don’t use it:
In the present exceptional circumstances, when expanding private credit and spending is so hard, if not downright dangerous, the case for using the state’s power to create credit and money in support of public spending is strong. The quantity of extra central bank money required would surely be smaller than under today’s scattergun quantitative easing. Why not employ monetary financing to recapitalise commercial banks, build infrastructure or cut taxes? The case for letting fiscal deficits facilitate private deleveraging, without undue expansion in overt public debt, is surely also strong.
Now, some might argue that central banks are already engaging in such a policy. They’re buying hundreds of billions of dollars worth of government bonds with freshly created money, the famous quantitative easing. True, in the US, the Fed can’t buy Treasury bonds directly from the Treasury. The Fed has to buy bonds from banks that own them. But the effect is similar with Federal Reserve cash essentially flowing into the market for US government debt. And other central banks, from the Bank of England to the ECB and the Bank of Japan, have engaged in similar undertakings in recent years.
So if the central banks are already taking Wolf’s advice, whom is this column aimed at?
It’s aimed at the governments. Wolf is saying that governments have to take advantage of the easy money that central banks are offering them and spend it to stimulate the economy. After all, the banks look reluctant to do it.
In other words, in the aftermath of a financial crisis, the fiscal authorities (the elected government) and the monetary authorities (the central bank) both have a job to do. The central bank should print the money and the government should spend it. In short: austerity = bad.