Bill White’s commentary responds to my argument, set out in a lecture at Cass Business School, that overt monetary finance (OMF) of increased fiscal deficits should not be a taboo policy option. My purpose was not to recommend specific policy actions in particular countries, but to widen the scope of debate about our policy response to the still profound challenges facing the advanced economies. White’s response is immensely valuable, engaging in detail with the arguments, rather than simply recoiling from the unmentionable.
There is a huge amount in White’s analysis with which I agree. As he stresses, the most fundamental driver of financial instability is the ability of fractional reserve banks (and shadow banking systems) to create credit and money, and thus to inject additional spending power into the economy. That capacity, described by Knut Wicksell in Interest and Prices, can sometimes support useful reflation; at other times, it can produce harmful inflation; at still others, harmful post-crisis deflation may result, as credit and money are destroyed. It can drive the real over-investment cycles feared by Austrian-school economists like Ludwig von Mises and Friedrich Hayek, and can drive harmful booms and busts in prices of existing assets, as described by Hyman Minsky.
The importance of these credit-cycle effects has increased greatly over the last 50 years, as the scale, complexity, and global interconnectedness of credit and maturity transformation processes has relentlessly increased. But, oddly and dangerously, their importance has largely been written out of modern macroeconomics, which has treated money as a neutral veil and paid little attention to the details of the credit and money-creation process.
White and I agree that the fundamental driver of the 2007-08 financial crisis was a huge increase in leverage throughout the economy. This “supercycle,” as White (quoting George Soros) calls it, was enabled, facilitated, and accentuated by Greenspan “puts” and financial liberalization. And it was viewed as benign by central banks convinced that the attainment of price stability was sufficient to ensure a lasting “ Great Moderation” of economic volatility .