As Frank suggests it is not possible to say everything necessary to develop an argument in a letter to the Financial Times so I will cover two things here that may add context to my disagreement with the 19 economists. Firstly a list of the fundamental differences between myself and them and secondly I will correct Frank, particularly where he attributed to me things I did not write. Firstly:
- There is only one cause of inflation which is too much money chasing too few goods and cost push inflation is a fallacy.
- It is not possible to close an output gap by using demand side policies. It is necessary to address supply side problems
- Inflation occurs when monetary demand grows at a faster rate than the rate of growth of output
- Zero inflation is ideal but not achievable without the risk of deflation. A 1% target is too low and was unsuccessfully used in Japan. A 2% target seems to be the safest target
- A Central Bank can manage money supply and its velocity creates the flow of monetary demand
- Monetary demand can be managed fairly precisely by volume of money controls e.g QE/QT/OMOs and it is not necessary to use base rates leaving market forces to determine interest rates and avoid bubbles.
- QE/QT/OMOs have small temporary effects on asset prices and interest rates
- Economic growth occurs when free market capitalism functions efficiently through invention , innovation and relative price changes
- Government spending reduces economic growth and does not increase overall employment, it just increases inefficient public sector employment and wasteful spending.
Those are the differences and here are the corrections:
“The theory is that only when prices begin to rise will stability, confidence and growth eventually return”
It is not when prices “begin to rise” it is when prices are low, stable and constantly growing at around 2%.
“The amount of money in the economy needs to exceed demand”
Monetary demand needs to grow at a slightly faster rate than the rate of growth of output (not demand) to achieve target inflation.
“So only when people start to see prices rising again,will they begin spending”
Prices need to be constantly rising around 2% and again there is no beginning or end.
“Hearn is also implicitly suggesting that business will only spend/invest if they expect inflation”
If business expects stable low inflation as a constant and reacts to market signals and relative price changes, then investment and growth will be at their highest
“Hearn is stating the conditions (low interest rates) are already in place which is why it isn`t clear why he thinks QE is necessary”
If I had time I would argue for much higher rates of interest to reflect a market price and, given the single cause of inflation, QE is one way to achieve target inflation. Central Banks can get it wrong because of time lags and other variables which is why UK inflation rose to 6% after QE: a lesson learnt I hope.
“QE doesn`t drive up the price of assets”
QE will have a temporary effect on asset prices but, on its own, will not cause rates to remain low and therefore not be responsible for bubbles.
So I stand by what I said and I hope the context provided explains the difference between myself and the 19 economists.
John Hearn 5/4/15