The Monetary Stimulus Myth – An Evidence based Analysis

This analysis examines the effectiveness of monetary policy as a contra-cyclical instrument. The survey covers three basic fields of monetary policy. The first part investigates to what extent expansion of the money supply effectively results in the alleged growth effect. The second section studies the effect of monetary expansion on money velocity. The third part investigates the outcome of interest rate policy on hoarding behaviour. Data covering 50 years of monetary history provide the evidence that expansion of the money supply has no significant effect on GDP growth. The impotence of monetary expansion proves to be due to the simultaneous decline of money velocity, which systemically neutralises monetary expansions. As to interest rate policy, the empirical evidence suggests that low interest rates have (besides the stimulating effect of boosting demand for credit) also the unintended outcome of weakening the eagerness to lend. Mispricing credit systemically unbalances supply and demand for loans. Interest rate suppression so constitutes a major cause of declining lending levels eventually resulting in a credit crunch. Low yields also tend to stimulate the liquidity preference and promote hoarding behaviour resulting in a further decline of money velocity. As a result, Keynesian low-interest rate policy is found to be counterproductive as a remedy against a credit crunch and recessions in general. Recent expansion of the monetary base resulted in a critical decline of the quality and liquidity of the assets held by both the ECB and the FED. The precarious liquidity deterioration compromises swift withdrawal of money from circulation should price inflation flare up. In conjunction with the massive accumulation of idle cash reserves, the central banks’ asset illiquidity constitutes a precarious recipe for run on hard assets and run away inflation.