A slightly off-center perspective on monetary problems.

What if cherry pie could cure cancer?

[After reading this post, please check out my related Econlog post, an increasingly rare example (for me) of a post where I discuss a NEW IDEA for monetary policy. At least new to me.]

Imagine a world where eating lots of cherry pie was bad for healthy people.  (Not hard to do.)  Now imagine that for some strange reason the consumption of cherry pie improved the health of cancer sufferers.  And the more you eat, the quicker you get over your cancer.  A slice after every meal is good for cancer sufferers; adding an afternoon snack is even better.  Sweet!

This scenario is fanciful, but actually does describe one important aspect of monetary policy.

When LBJ became president in late 1963, the economy was in decent shape.  It was three years into an expansion and inflation was less than 2%.  But he couldn’t leave well enough alone, and a couple years later began pressuring the Fed to stimulate the economy.  The Fed responded with a massive purchase of government debt, which led to a rapid increase in the money supply.  The monetary base had risen from $33.4 billion to $44.3 billion between November 1945 and November 1963, but soared to $83 billion by November 1973—the Great Inflation was underway.  BTW, these purchases reduced the value of US government bonds, for those worried about “Cantillon effects”.

Screen Shot 2019-01-06 at 2.13.29 PM

Just as eating too much pie is bad for a healthy person, monetizing lots of debt is bad for a healthy economy.  It causes high inflation, which discourages saving and investment.

Oddly, when the economy is so unhealthy that interest rates have fallen to zero, printing money to buy back the public debt becomes a healthy policy.  The more you buy the better you feel.  And it’s also highly profitable, at least in most cases.  Of course it’s theoretically possible that you’d buy assets with a lower rate of return than cash, which earns zero.  But that’s unlikely.

Because eating lots of cherry pie has a bad reputation, lots of doctors would discourage their cancer patients from eating too much for fear they might get diabetes. Even if consuming cherry pie worked miracles for cancer patients, some doctors would keep recommending chemo and radiation.  As an analogy, certain mushrooms dramatically reduce depression in patients with terminal cancer, but many doctors refuse to recommend this enjoyable drug because . . . well . . . I’m not sure why.  Perhaps it’s our puritan instincts.

Even though QE is a miracle drug that helps a zero bound economy get better and usually leads to big profits for the government, our economic doctors warn against taking too much of this delicious medicine.  After all, QE is bad for healthy economies.  In their view it’s better to rely on fiscal stimulus, which not only is not profitable, it imposes trillion dollar losses on the Treasury.  We live in a world where the Very Serious People tell us we need economic equivalent of chemo, not cherry pie.  Even though cherry pie is far tastier, and more effective.


PS.  Kevin Erdmann has a new piece in the Wall Street Journal.  Also, please order his excellent new book on housing, it will lead you to completely rethink many of your views of what happened during the boom and bust.



Related Posts: