Friday, 5 December 2008

"Quantitative Easing" here we come...

Quantitative Easing is central bank jargon for printing money. Rumours abound that the government and the Bank of England are looking at this as a way of sorting out the current financial crisis.

This search using Google shows the news reports for "Quantitative Easing" in the last week from when you click on it. Well it scared me... Do we really believe that our leaders have better judgement than the average Latin American dictator?

So, might their plan be? Well, suppose they think that we face a major deflationary future, the Bank may be expecting to see 10% price deflation. So, pumping the money supply by 10% per year should stop that. They could also be arguing that the velocity of money has decreased, so increasing the supply will just counter that.

This is so flawed, and so risky. Why? Well, cash money is such a small part of the economy - it is called M0 - is about one fortieth the size of M3 (a broader measure of money supply). However, it is unclear what impact increasing the cash money supply will have on the other figures - my guess is that it will be non-linear, and probably with a cusp in it. Let me explain...

I live just outside of Birmingham, a 12 mile drive. If I need to get somewhere in Birmingham I can either drive or take the train. Recently I needed to be in Birmingham at 9am. I took the train - why? Well, given the unpredictability of the traffic, I know how long it would take me to get there for 8am, or 10 am, but I didn't know what time to set off by car to get there for 9. The traffic is so chaotic that it is impossible to predict what time to leave to get there for 9.

Likewise, the amount of money to print to balance the deflation is probably impossible to predict. I suspect that it is possible to print too much or too little and impossible to print the right amount.

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