The Real Economy

The outcome of quantitative easing on real incomes - summary note

Hector McNeill¹
SEEL

In the article entitled, Real Incomes & the Quantity Theory of Money, I set out the practical gaps in the quantity theory of money. These related to the complete lack of a direct relationship between producivity and real incomes growth to monetary policy. In summary, monetary policy, based on this theory, cannot serve the real economy.

With the operation of quantitative easing since the 2008 crisis, vast amounts of evidence has accumulated that confirms this statement. We can now see the consequences of a poor macroeconomic policy that has relied excessively on the monetary element, based on a government mantra that keeps insisting that we are witnessing growth and more employment; but the prospects for the UK economy are being undermined. This article explains what is going wrong and I set out more practical macroeconomic options in relation to money for the UK. This article is best read following a review of the previous article.

The chart on the right shows negative impact of Quantitative Easing (lower interest rates and increased money volumes,

through bank issued debt¹ which has resulted in the migration of money to FICRESS² assets (blue line) leading to a starvation of real invesment and returns and in particular real incomes of lower income segments (green line). Moving from quantiative easing and with monopoly imposition of higher interest rates (orange line) bank deposits rise to gain interest payment as returns. However, the interest rates become prohibitive for real sector investment.

In the case of the natural interest rates³ and real incomes Price Performance Policy (PPP) transforms the real incomes response curve to the real incomes price performance response curve augmenting returns on investment and real income levels, in particular, reducing the precariousness of the lower income segments. Moving from quantiative easing but without policy intervention by imposing higher interest rates than the natural rate the response is shown as the PPP curve (red line). This significant gain in real incomes and returns on investment arises from a reduction in inflation⁴, a recovery of higher returns on savings, the draining of speculative FICRESS activity and incentive for banks to advance loans at reasonable rates for investments in the real economy.

¹  The increase in money volumes arises from bank issuance of debt as explained by Bank of England brief: "Money creation in the modern economy"; for further explanation return to home page click on the link, lower down, "The monetary paradox").
²  FICRESS is Finance, Insurance, Commodities, Real Estate and Stocks and Shares (for further information on FICRESS return to home page and click on the link, lower down, "The monetary paradox")
³  Natural interest rates are freely established as a discount on actual returns on investment. Natural interest rates are not subject to monopoly market intervention by the state, imposing arbirary rates which distort the free market (current basis for montary policy). This concept was developed and explained by the economist Johan Gustaf Knut Wicksell (for further information on natural interest rates return to home page and click on the link, lower down, "The monetary paradox").
⁴  PPP secures a strong incentive for inflation reduction through the use of the Price Performance Levy where rebates are gained to the extend that unit price inflation is reduced (for further information on this process return to home page and click on the links, lower down, "The Price Performance Ratio" and "The Price Performance Levy").