According to most economic experts, when an economy falls into a recession the central bank can pull it out of the slump by means of money pumping. This way of thinking implies that money pumping can somehow grow the economy. Indeed US historical evidence supposedly does show that easy money policy seems to work. For instance on average between 1970 and 2018 it took about 11 months before increases in money supply were followed by increases in the growth rate of industrial production.1
The question is how is this possible? After all if money printing can grow the economy then why don’t we print plenty of it to generate massive economic growth? By doing that, central banks could have created an everlasting prosperity for every individual on the planet.
For most commentators the arrival of a recession is due to unexpected events such as shocks that push the economy away from a trajectory of stable economic growth. Shocks weaken the economy, i.e., cause lower economic growth, so it is held.
A likely explanation lies in the fact that as a rule, a recession emerges in response to a decline in the growth rate of the money supply. Usually this takes place in response to a tighter stance of the central bank. Various activities that sprang up on the back of the previous strong money growth rate (usually as a result of loose central bank monetary policy) come under pressure.
These activities cannot support themselves — they survive because of the support that the increase in money supply provides. The increase in money diverts to them real wealth from wealth generating activities. Consequently, this weakens these activities, i.e., wealth-generating activities.
A tighter stance and a consequent fall in the growth rate of money undermines various nonproductive activities and this is what recession is all about. Given that, nonproductive activities cannot support themselves since they are not profitable, once the growth rate of money supply declines, these activities begin to deteriorate. (A fall in the money growth rate means that nonproductive activities access to various resources is curtailed.)
Recession then is not about a weakening in economic activity as such but about the liquidations of various nonproductive activities that sprang up on the back of an increase in money supply.
Why the GDP Framework Presents a Misleading Picture
Economic growth is presented by government statisticians in terms of monetary expenditure data such as gross domestic product (GDP) and industrial production. These indicators are designed along the line of thinking that spending equates with income — hence more spending leads to a higher national income and in turn to a higher economic growth.
On this logic, a tighter monetary stance by the Fed leads to a slower economic growth whilst increases in the money pumping produce higher economic growth. (A stronger growth rate of money supply leads to a stronger pace of expenditure.) In the GDP framework this leads to an increase in overall income in the economy and hence to a higher GDP growth rate.
We suggest that in reality the exact opposite actually takes place — printing more money weakens wealth generators’ ability to grow the economy while a decline in the money supply growth rate strengthens their ability to grow the economy. (Note that an increase in the money supply results in an exchange of nothing for something.)
Once the central bank raises the pace of money pumping in order to lift the economy from a recession this arrests the demise of various nonproductive activities. It also gives rise to new nonproductive activities.
The outcome of so-called economic growth in this case is nothing more than a strengthening of wealth-consumers at the expense of wealth-generators. All this undermines the process of wealth generation and weakens the true economic growth.
Real Wealth Funds Economic Activity
Irrespective whether an activity is productive or nonproductive, at any point in time the number and the size of all activities that can be undertaken is determined by the available amount of real wealth. From this, we can infer that the overall rate of increase in productive and nonproductive activities as a whole is set by the rate of expansion in the pool of real wealth.
Observe that this runs contrary to the GDP framework where the pace of monetary expenditure, i.e., money pumping sets the so-called economic growth. This however does not make much sense.
After all, individuals, whether in productive or nonproductive activities, must have access to real wealth in order to sustain their life and well-being. Note that money cannot sustain individuals, it can only fulfill the role of the medium of exchange.
According to Rothbard,
Money, per se, cannot be consumed and cannot be used directly as a producers’ good in the productive process. Money per se is therefore unproductive; it is dead stock and produces nothing.
As long as wealth producers can generate enough real wealth to support productive and nonproductive activities, easy monetary policies will appear to be successful. (Equivalently, loose fiscal policies are similar to money policy since they also impoverish wealth generators.)
Over time, a situation may emerge where there are not enough wealth generators left due to the persistent loose monetary and fiscal policies. (Wealth generators have been badly damaged by these repeated loose policies over time.) The implication of this is that the real wealth being generated may not be sufficient to support an increase in economic activity. Once this happens, the illusion of loose monetary policy is shattered — real economic growth must come under pressure.
The government’s attempt to boost the growth rate of GDP by raising its own expenditure is also going to fail if the supply of real wealth is dwindling. After all government activities also require real wealth. (Remember every activity irrespective of whether it is productive or nonproductive — must be funded). If the government were to persist with its aggressive stance, this will only make things much worse. (It will deprive funding from wealth generating activities.)
Likewise, if the Fed were to accelerate its monetary pumping while the pool of real wealth is declining this runs the risk of severely damaging further the pool of real wealth. Those commentators who subscribe to the view that the acceleration of money pumping here could fix things hold that something can be created out of nothing.
From this, we can deduce that there is no such thing as stimulatory policies that can grow the economy. Neither the Fed nor the government can grow the economy. All that stimulatory policies can do is to redistribute real wealth from wealth producers to nonproductive activities. These policies encourage consumption not supported by the wealth generating production.
Conclusions
So-called economic growth in response to loose policy simply mirrors the monetary expenditure growth rate and not true real economic growth. Since economic indicators such as GDP and industrial production reflect monetary expenditure, hence the more money pumped by the Fed, the larger the so-called economic growth is going to be. Over time however, a situation can emerge where there are not enough wealth generators left due to persistent loose monetary and fiscal policies which erodes their ability to generate real wealth. Consequently, the real wealth that is generated may not be large enough to support an increase in economic activity. In this situation neither loose monetary policy nor loose fiscal policy can “work.”
- 1This correlation is based on measuring industrial production and money supply using the “Austrian Money Supply” measure.
