Keynes and Quantitative Easing

Nov.5, 2010, 11:22 a.m.

A number of Keynesian economists have been sceptical of quantitative easing as a useful supplementary technique because they believe that in a deep slump monetary policy is like pushing on a string and will be ineffectual because interest rates are already very low and the speculative demand for cash balances very high. What this translates into is the quasi hoarding of cash balances. What is needed they argue is much more fiscal stimulus to boost investment and job creation. Well in part, of course,  I agree with them that additional fiscal stimulus is very necessary to boost aggregate demand sufficiently to push employers to hire more workers and to hire more directly through additional infrastructure investment undertaken by government.

But I also advocate quantitative easing to ensure an accomodating monetary policy. I have done so since my work on it in the 1980s. The point of quantitative easing is that it helps prevent any interest rate crowding out by ensuring that rates stay low while the fiscal stimulus is financed. In disinflationary and near deflationary slumps the risk of inflation is minimal.

But in addition it is useful to know that Keynes himself approved of this approach. In March of 1930 before the Macmillan Committee in the U.K. of which Keynes was both a member and also a major witness he argued in favour of this policy as follows.

 ''My remedy in the event of the obstinate persistence of a slump would consist, therefore, in the purchase of securities by the Central Bank until the long term market-rate of interest has been brought down to the limiting point....(with respect to the 1930s slump) the Bank of England  and the Federal Reserve Board (should) put pressure on their member banks...to reduce the rate of interest which they allow to depositors to a very low figure, say 1/2 per cent...(and) these two central institutions should pursue bank-rate policy and open market operations à outrance.''

(See Report of the Committee on Finance and Industry (Macmillan report), 1931 Vol II, p.386. cited in Benjamin Higgins,'' Keynesian Economics and Public Investment policy'' in  Seymour Harris,ed. The New Economics, Keynes' Influence on theory and public policy, N.Y.:Alfred A.Knopf, 1948, p.470 note 9.See also Peter Clarke, The Keynesian revolution in the making 1924 - 1936, Oxford:the Claredon Press, 1988.pp.150ff )

Later in the General Theory developed his ideas of fiscal stimulus further and appeared to give more emphasis to fiscal policy in the context of a multiplier enhanced stimulus. But monetary policy was always part of his tool kit and it should remain part of ours.