Thursday, March 19, 2009

Monetary Easing and the UK Downturn - Brown must bail out the poor!

Monetary easing has begun.
The problem is that it looks unlikely to push pounds into the spender's pockets. Instead, it will provide banks with assets which have dematerialized since the meltdown, rather than increase the amount of money in circulation.
Here is a quick heads-up on monetary easing. PQ=MV (where P is Price, Q is Quantity, M is amount of money available and V is its speed of circulation). A slowdown generates primarily a reduction of V, which the treasury is trying to address by increasing M (so as to keep P, but more importantly Q, constant). The problem with the current situation - and this has already shown when the Bank of England cut down interest rates in order to facilitate lending - is that banks do not lend anymore. Banks are doing what every business that has not gone under is doing right now. They are simply trying to stay afloat. The sad truth is that we cannot really blame them for that. Do you really want to see your bank lending money to a poor Joe about to lose his job?
If monetary easing is to work (and stimulate the economy) in the current situation, the money put in circulation must well, circulate (i.e. it must be spent). The general feeling among consumers is not to spent (clue the past two quarters retail figures and this kind message on the high street). If money is to be provided efficiently, it has to be made available not for those who need the money (i.e. banks, mortgage owners, etc.) but for those who need to spend it (i.e. those with the smallest disposable income).
In short, the only way to see this measure work is to ensure that those who will spend money (because they must; i.e. because they are hungry, because they are cold, etc.), have access to it.
By providing employment to the chronically unemployed - even part time employment - Gordon Brown can ensure that this additional money will find its way into the economy. Ideally, this newly created employment should be in the sector of renewable energy (two birds, one stone, anybody?), but providing additional resources to traditionally state funded sectors that have notoriously failed in the past (NHS, education, etc.) would also benefit from the support of the public opinion (a thing that bank bail outs have failed to do).
The argument is that making this money available to someone slightly better off could be counter-productive as they would create a cushion (saving) in case things really get worse (recession could become depression). Whilst savings are essential in a healthy economy (E=I where E=savings and I=investments), it would not work in the time available. As we have seen, the banks have stopped lending and it will take some time before they start lending again.
Is it time for New Labour to go old-school?

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