The bubbles foaming from Paul Krugman’s soapbox seem to have gone to his head. As Krugman now claims, the central bank is incapable of directly affecting the amount of money in the economy. All it can do is adjust the level of bank reserves. Whether these adjustments lead to changes in checking deposits is then left to fate and fortune.
He is wrong, clearly. While it is true that banks won’t automatically create money through loan growth, the central bank can still inject new money. Any non-bank who sells bonds to the central bank during its open market operations will receive freshly minted checking deposits. For that matter, any non-bank who sells an investment to a bank does as well. So it follows that whenever the central bank buys copious amounts of bonds on the open market, it is likely – very likely – that some of that money ends up not just as bank reserves, but as actual money. Money we can buy stuff with.
The numbers prove this. From September 2008, when Bernanke ramped up the printing press, to September 2014, the M2 money stock grew by 45%. Instead during our last business cycle, from September 2002 to 2008 (Bernanke’s pre-helicopter days), M2 only grew by 39%. The difference is significant. 6% translates to $500 million in M2 growth during similar time lengths. And the effect on M1, a measure which counts only money we can use to buy goods and services, is even larger: $500 million is a whopping 33% of September 2008 M1. So the Fed has boosted checking deposits. The data bears this out.
What’s more, this analysis most likely underestimates the Fed’s achievements. During the 2002 to 2008 period, the economy experienced a tremendous economic boom. Growth in loans and investment was rampant. Greasing this debt binge was newly created money. Since 2008, on the other hand, the US economy has suffered immensely. Money evaporated as the private sector deleveraged.
In others words, the boom boosted M2 growth, while the bust sapped it. What this means is that, as a direct result of quantitative easing, the Fed not only replaced all the net outflows from deleveraging, but injected $500 million more.
So Krugman, yet again, is wrong. Central banks can control the broader money supply. If it wanted to, the Fed could decide tomorrow to buy every financial asset in existence, from banks and non-banks alike. The trickier question, as it has always been, is whether swapping financial assets for new checking deposits leads to an increase in nominal spending at the Zero Lower Bound.
That’s where the rub is. Demand, always demand.