Robert Murphy criticized David Beckworth's conservative case for quantitative easing.
For the most part, Murphy fails to understand the quasi-monetarist position. Beckworth correctly understands that the purpose of quantitative easing is to expand the quantity of money, correct the imbalance between the quantity of money and the demand to hold it, and so, expand spending on final goods and services--particularly consumer and capital goods.
Beckworth doesn't think the purpose of the policy is to lower interest rates or expand industrial or commercial bank loans. Murphy's statistics about interest rates on government bonds and the volume of commercial and industrial loans are irrelevant. As I have explained before, quantitative easing can increase spending on goods and services while real interest rates rise and lending by banks or even total lending falls. All it requires is that some of the households and firms that reduce lending use the funds they would have lent to instead purchase consumer or capital goods.
Murphy's argument against the desirability of expanded spending is almost nonexistent. Neither Beckworth nor any quasi-monetarist claims that spending creates wealth without production. Further, we understand the importance of expanding the productive capacity of the economy through saving, investment, and technological innovation However, we also recognize that in a market system, productive capacity will do no good if firms cannot sell what they produce. And so, real expenditure must grow with the productive capacity of the economy. That requires that money expenditures grow or else the level of prices and wages fall. Our view is that growing money expenditures is a better way to allow firms to sell what they are able to produce than requiring a deflation of prices and wages, particularly a deflation made necessary by a large drop in money expenditures.
We cannot "inflate" ourselves into jobs, says Murphy. If we assume that the prices and wages are at the level where the real quantity of money equals the demand to hold it, then expanding the quantity of money will do no good. But if the prices and wages remain too high for the real volume of expenditure to match the productive capacity of the economy, increasing the quantity of money means that prices and wages don't have to fall as much as they otherwise would. In the limit, prices and wages don't need to fall at all and, in fact, can continue to rise at their previous trend.
In the end, Murphy criticizes quantitative easing because when the Fed purchases $600 billion in government bonds, it is purportedly distorting the market by providing the Federal government with funds at preferential rates. By lending to the government, the Fed is distorting the market by directing credit towards the government rather than the private sector.
At first glance, the argument is absurd. Does Murphy really think that the U.S. government will spend $600 billion more in 2010 and 2011 because the Fed is purchasing $600 billion more government bonds? That if the Fed instead purchased a portfolio of private securities, the U.S. Treasury would have to sell fewer bonds over the next year because it couldn't find buyers? And so, the U.S. government would have to limit its spending because of a lack of funds?
I think a much better vision of the current fiscal situation in the U.S. is that the government spends what it likes, collects taxes as it can, and borrows the difference. The U.S. government has no problem finding buyers for its bonds, and is able to borrow at historically low rates.
However, there is probably one element of truth in Murphy's argument. If quantitative easing did lower interest rates on government bonds, then this would reduce the government's interest expense. Because of public concern about budget deficits (which I share,) this reduction in interest expense will reduce the pressure on the government to hold the line on other elements of government spending or increase taxes.
Still, I am not certain that the alternative of the government paying its bond holders more and spending less on other government programs is especially desirable. I am sure that paying its bond holders more and raising taxes would be worse. My own preference is that other government spending should be cut regardless of what happens to the government's interest expense. If there is any change made to the budget due to lower interest expense, it should be lower tax rates.
However, as explained above, quantitative easing might actually raise interest rates and the expense of funding the national debt. When the economy is depressed, investors seek safety, which includes government bonds. Since the point of quantitative easing is to increase spending by households on consumer goods and spending by firms on capital goods, and so, generate an economic recovery, investors should feel less need for safety and may move away from government bonds. That the interest cost on the national debt might rise is a cost well worth paying for economic recovery.
However, having a monopoly central bank direct investment is problematic. The solution is simple. Privatize the issue of hand-to-hand currency, abolish reserve requirements, and set the interest rate paid on reserve balances below the interest rate that can be earned on short term government bonds. This would greatly reduce the demand for base money, and so, minimize the impact of the Fed on investment decisions. The investment decisions would be made by the banks that issue the private currency and deposits used as money or for saving purposes.
The worst possible situation is for the Fed to pay high interest on reserves, causing an increase in the demand for base money, and then directing credit where it thinks best. In other words, the worst possible policy was the misnamed QE 1, really an effort by the Fed to "fix" credit markets. While QE 2 is far from prefect, combined with a commitment to fiscal responsibility, it does not manipulate credit markets in the favor of the government, and is better than leaving the quantity of money below the demand for hold money and real expenditure below productive capacity.