Monday, 27 January 2014

The Ricardian Equivalence Hypothesis

Sometimes you write a nice whimsical blogpost about how money isn't very much like ice-cream but could be more so and you think that's that and start to wonder about what to write for next week's post (maybe a nice poem about a juggler who falls in love with a knight or something) when 'ding' you notice that someone has left a comment.

Now, I don't get a lot of comments on my blog (even when I set fiendishly difficult riddles in mock Old Norse verse patterns for my readers to solve) so you can imagine how excited I was to read a response to my daydream of time-limited money being dropped into everyone's bank accounts. And then how disappointed I was to read that there are people out there that don't believe that ice-cream money would save the economy after all, in the words of 'JR':

Your theory sounds wonderful, but (and mostly to play devil's advocate), surely if you gave every person in England a £10,000 windfall, most of them would spend it repaying a loan they took out from the bank (or on the things they would have bought anyway, so they can pay the 'other' money back to the bank instead), so all the "spare" money would end up with the banks anyway? JR 

Incidentally, I meant to mention last week that the government of the UK has spent £200 billion on Quantitative Easing in the current crisis, had that money gone directly to the people that would have been a whopping £3,166 each! JR has ruined this statistic by making my figure look paltry next to his one.

A healthy economic community is one where each pound keeps getting spent and even when it winds up in the bank, the bank lends it out again. And, even though there isn't anything like enough cash for everyone to have all their money at once, everyone pretends there is and carries on sharing the same few pounds. You see this in action if you work in a bar, where you keep getting the same ratty fiver handed back to you. In a healthy economic community that fiver has got ratty because it has been through the tills and paypackets of so many local businesses.

If a government gave the money directly to the people some of it would become the useful type of money described in the previous paragraph. If the money had a time-limit on it (i.e the initial receiver can't just leave it in the bank) all of it would. 

I'm not sure that JR's argument holds even in the classic helicopter drop of giving everyone extra cash. We are not all rational actors who notice, a la David Ricardo, that this money can't just appear from nowhere, government bonds have to be repaid, taxes are going to go up, I better save my money. A lot of people would just think: 'Woohoo! free money! I'm going to buy a motorbike!' 


  1. Yep, I agree that some people would go and buy a motorbike. But the problem is that the guy they buy the motorbike from would then use to repay the loan he had from the bank. What the government has got wrong is that they've whipped up hysteria about the evil bankers (with justification originally), but in the process they've scared the banks off doing what they need to be doing to get the money circulating again. You're totally right that the banks lending money is what's necessary. But at the moment they're not doing it, because they spent years giving 95% mortgages to people who couldn't repay them with the interest rates at the time. That was thoroughly irresponsible. They all got their fingers burned, and now they'll lend you something like 70%, because they're frightened of doing it again. But that makes absolutely no sense, because interest rates are at record lows, so the people who originally couldn't afford it now could.

    So, rather than wittering on about bankers bonuses (which are obscene to the man on the street, and make good headlines in the press, but are actually irrelevant to big picture), Cameron needs to tell the banks that if they want to hold a banking licence in the UK, they need to be prepared to make suitably sized (but not irresponsible) loans to small business operators, and individuals in the street, so that 25 year olds with a job can buy houses, the corner shop down the road can afford to build an extension, and someone who leaves school with a sensible idea can find some way to fund it.

    This has got rather heavy. I think, in essense, we probably agree, we're just disagreeing on where the money should come from. I don't think a windfall is necessary. The banks already have it. The government just needs to concentrate on making them give it out in exchange for their licence which allows them to make money out of the financial system. JR

  2. I wish I'd left school with a sensible idea...