(1/n) So, the idea is basically this: the whole economy is being forcefully shut down for an unknow time period. We don't want business to go bankrupt as we want to simply "turn them back on" when we can go outside again.
(2/n) But the problem is the most typical Microeconomics 101 issue of fixed costs. Even if the businesses do not operate and eliminate the variable costs, they have fixed costs that they cannot eliminate (same goes for households).
(3/n) And if we want to keep the same level of employment, we need to put labout under "fixed costs".
(4/n) To cover the fixed costs and prevent them from going bankrupt, we need to put them on life support for the time being. That comes in two ways: direct money to consumers and direct money to businesses.
(5/n) Put both together, both in the EU and US, the rescue package is several trillion EUR/USD.
There is no way that gvrnments can borrow that much that quickly. And even if they could, the interest payments would kill them. The only alternative is to borrow from central banks.
There is no way that gvrnments can borrow that much that quickly. And even if they could, the interest payments would kill them. The only alternative is to borrow from central banks.
(6/n) The idea there is for governments to issue zero interest rate bonds with undefined due-date (or some ridiculously long due date like 1000 years). Then the central banks run the printing press, issue new money and buy the bonds from governments.
(7/n) This gives governments a few trillion, which is enough to support economies for a few months. But there are a few problems that I don't see being discussed.
(8/n) What if the situation persists and we need another bailout? How many times can we print money before unreversibly damaging the monetary system?
(9/n) The bonds will basically be worthless to anyone who holds them. CB will therefore not be able to sell them to anyone other than the original issuer. It is unlikely that governments will ever be able to repay that amount of debt.
(10/n) A far more likely scenario is that the bonds will simply be written down. That means CBs will have a massive holes in their balance sheets. That is problematic if, when the economy is kickstarted again, there is a huge and sudden increase in demand (which is very likely).
(11/n) Supply can, even in the best of times, only be increased gradually. More so after a few months of complete inactivity. High demand and low supply means a quick increase in prices.
(12/n) Assuming we are successful at keeping people afloat during the crisis (whis is why we are doing this in the first place), they will still have a fair bit of purchasing power and will be eager to "make up for lost time". They will go after goods and services.
(13/n). That wil push us towards hyper-inflation. To counter this, CBs will need to act. They can do this in several ways. One is called "open market operations" - buying or, in this case, selling the bonds that it has on its balance sheets.
(14/n). With this, there are two issues: firstly, the 0 interest rate, unlimited maturity bonds will be written down, so there is nothing to sell there (and if there was, there would be no buyer).
(15/n) So it might be completely possible, that the remaining balance sheet is simply not large enough (not enough things to sell) to get as much money out of the system as needed to curb inflation.
(16/n) Secondly, as many of the bonds that CBs hold, have a fixed interest rate, their price is partly determined by inflation. The higher the inflation, the lower the price of the bond.
(17/n) So, CBs will be in a position where they need to sell assets to fight inflation, but that same inflation will cause their assets to be worth less and less, further reducing the "firepower" of CBs tofight inflation.
(18/n) CB also has other ways to fight inflation, aside from open-market operations. It can, for example, tell banks to increase their fractional reserves, thereby reducing the money multiplier, which effectively reduces the amount of money in the circulation.
(19/n) This might be an elegant way for the CB to fight inflation, but it is not without consequences either. In the worst case scenario, it could cause some of the banks to go bankrupt.
(20/n) In the best case scenario, banks will dramatically reduce lending in times when economic expansion is much needed to meet the rising demand.
(21/n). I'm sure there are other ways that I don't know of, or even ways that we have never tried before. But my point is this: do not, for one second, think that running the printing press is a "get out of jail free" card and that we can simply legislate our way to prosperity.
(22/n) One way or another, we will have to pay for shutting down the global economy.
Cc: @jdamijan @LukaMesec @PocivalsekZ @strankaSD @markopahor @Libertarec
Cc: @jdamijan @LukaMesec @PocivalsekZ @strankaSD @markopahor @Libertarec
