Since the 2008 financial crisis, the Western world's major advanced economies have found themselves in a bit of a funk. The worst of the crisis is over, but we seem to be, somehow, stuck in second gear. Incomes aren't growing fast enough, unemployment is still too high, interests rates are very low, and inflation is extremely low. And the entire world of policymakers, economists, central bankers, and the like, is sitting around wondering why, and what to do about it.
Some are calling this "the Great Stagnation." Others call it "The New Normal." But whatever you call it, it's real.
Japan has been battling similar stagnation for well over 20 years, much longer than we have, and has tried a lot of things to get itself out of it, some successfully, some less so. In a way, Japan is a sort of microcosm, a laboratory for what could and couldn't work for the U.S. and Europe, which is what makes its recently announced new monetary policies so interesting. Here's what's going on: The Bank of Japan is introducing a yield curve target, and an inflation overshoot pledge. And while these are good moves, they don't go nearly far enough.
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The yield curve is the difference between the interest rates of various maturities of a set of bonds — in this case, government bonds — which shows investor expectations of the future health of the economy. Capping the yield curve is basically another way to keep interest rates down, therefore kickstarting the economy by getting people to lend, borrow, spend, and invest. This way of doing it is new, and in some ways even more radical than lowering interest rates or quantitative easing (printing money to buy assets).
But the Bank of Japan's other move — the inflation overshoot pledge — is even more interesting. One of Japan's major problems is deflation. Deflation can murder an economy: If prices keep dropping, people keep putting off purchases, which means prices keep dropping, which means people keep putting off purchases. It creates a self-sustaining economic slump. One way the Bank of Japan has tried to fight this is through an inflation target of 2 percent. But it keeps missing that target. So now it's saying that even if inflation goes higher than 2 percent, it's not going to do anything about it. In other words, the Bank of Japan is pledging to let inflation overshoot its target.
The central bank is hoping to change the economy simply with a declaration, which, if you think about it, isn't entirely crazy. If you have the capacity to produce an infinite amount of something — as the central bank does money — people in the market for that something will hang on your every word. Imagine that I am sitting on infinite oil reserves and everyone knows it. I put out a press release saying, "If the oil price doesn't drop by $10, I'll pump enough oil out of my reserves until it does." The price would go down by $10 immediately, and I wouldn't have to pump out any oil, because traders would adjust, knowing that if they pushed the price higher, I would deliver on my threat.
Unless, that is, they had some reason to doubt me. And indeed, there are a lot of reasons (political constraints, fear of runaway inflation, to name a few) why central banks don't exercise their right to print infinite amounts of money. If the market thinks the central bank is bluffing, it won't respond.
Hence, then, the "inflation overshoot pledge." The central bank is essentially saying to the economy: "Look. Maybe you're not taking my inflation target seriously because you think if I get too close to the target I'll get cold feet and start turning off the spigot. Well, I'm tying myself to the mast: Not only is the target still on, but if I overshoot, I'll still keep the monetary tap on." This is a big deal, because it's breaking a huge taboo. Central banks are supposed to hate inflation. But now the Bank of Japan is saying "Bring it on."
This is a fascinating game to play with trillions' and trillions' worth of values across economies. But I don't think these moves are radical enough. Policies like lowering interest rates, buying bonds, and setting inflation targets work only indirectly on the economy. Sure, without low interests and quantitative easing, the U.S., Europe, and Japan would be much worse off today — but only partly. The Bank of Japan still hasn't hit its inflation target. No economy is doing as well as central banks hope. The impact is real, but it is essentially muffled, because it needs so many middlemen for the impact to reach the real economy.
The other problem is that, unlike the unjustly-tarred Reagan-era supply-side economics, this is literally trickle-down economics. Monetary easing policies work, essentially, by making asset holders — aka the rich — richer, which, in theory, gets them to spend and lend more money, which makes the economy run better. But at what cost?
We shouldn't be surprised that inequality has been increasing, even as wages have been stagnating, for the past 25 years, over the same period as central banks have decided to fight recessions with those sorts of monetary tools. I'm not freaking out every day about inequality, but I also don't see why we should purposefully increase it if there's a better alternative out there.
And there is an alternative, a very simple one. Remember, the central bank can print infinite amounts of money. Why not just send that money to people? This is known as a "money drop," and it's the biggest taboo of monetary policy, because people are afraid it would lead to hyperinflation. But there's no reason to think that, if used properly, it would lead to hyperinflation any more than any other monetary policy tool.
If I had my way, the bank wouldn't write checks to people. Instead, the government would stabilize employment by cutting payroll taxes — taxes on work — and those tax cuts would be financed by money printed at the central bank. It would be the ultimate macroeconomic stabilization tool. Payroll taxes and wage subsidies essentially allow the government to push up, or down, the price of work in the economy (without penalizing workers). In a recession, companies can't afford workers anymore, so they lay them off. Lower the price of hiring until the situation is stabilized again. Then once people have jobs, they can spend money on what they like and drive economic growth.
Instead of putting trillions' worth of newly created money in the hands of very rich people and waiting for it to literally trickle down somewhat, it would be going into the wallets of those who matter most: workers and businesses. There is absolutely no theoretical or practical reason not to do this.
