Tag Archives: Open Market Operations

Should We Print Money For Aid?

I recently sat down to watch an interesting TED talk by Michael Metcalfe, a senior managing director at State Street Global Markets, who brought up a few interesting ideas about the way we fund our foreign aid programs. Metcalfe begins the talk by introducing a few interesting observations about the global economy. He first addressing the contradiction in foreign aid policy in developed countries. Metcalfe points out that, although the United Nations has put forth the incredibly ambitious Millennium Development Goals, which include halving extreme poverty rates and halting the spread of HIV/AIDS by 2015, the ratio of foreign aid to national GDP of developed countries has stagnated around 0.35%, even though aid targets remain at 0.7% of GDP. He asserts that foreign aid payments have also dropped since the financial crisis, and that progress towards our ambitious development goals will remain slow if this problem is not properly addressed. His solution? Simply print money for foreign aid.

At the basis of Metcalfe’s idea is the suggestion that the money supply doesn’t affect inflation as drastically as many believe. He explains that despite the U.S. Federal Reserve’s multi-trilion dollar asset purchasing program, the inflation rate in the U.S. has remained relatively unaffected 6 years later. Indeed, if we use the Consumer Price Index as a strong proxy for annual inflation in the U.S., then it does appear that the price level, apart from a small and temporary increase during the recession, hasn’t dramatically risen since the financial crisis. Screen Shot 2014-04-05 at 9.19.05 PMBuilding the foundation of his argument upon this information, Metcalfe asserts that we should take a fraction of the money that was printed to stimulate the economy and send it to countries who rely on foreign aid. Like a firm that matches the charitable donations of its employees, the U.S. central government could encourage the Federal Reserve to match its contributions to its annual foreign aid payments. Furthermore, since these payments would be going overseas, he explains that it’s not obvious how this form of funding would directly contribute to inflation in the central bank’s home country. According to Metcalfe, this could dramatically increase the amount of foreign aid payments to developing countries with limited risk to creating inflation and smaller requirements from the central government’s coffers.

At first glance this looks like a very interesting idea, and one that seems certain to garner praise. I mean, who wouldn’t want to eliminate eliminate global poverty with a few keystrokes from the FED? On the other hand, there do appear to be a few inconsistencies with his logic and methods that could prove problematic. First, I would be careful not to make the assumption that just because inflation didn’t appear to increase much after QE, that printing money doesn’t cause high levels of inflation. While it is true that the central banks of the U.S., UK, and Japan created around $3.7 trillion to help push the global economy out of a recession, that doesn’t mean that all of this money made it out into the economy. As we’ve all learned in Econ 102, the Federal Reserve adjusts the money supply though Open Market Operations, in which it buys securities from national banks. These banks are then supposed to take this newfound money and loan it out to individuals, whereupon it the money will have a multiplicative effect after individuals deposit their loans in other banks, who lend out a share of this money to other individuals, who deposit it in other banks, so on and so forth. A problem occurs, however, when banks decide not to lend money to individuals. This was an apparent phenomenon during the financial crisis when banks decided to hold on to the Fed’s newly invented money in in fears of the risk of financial collapse. We actually see there is a steep decline in the number of loans make by commercial banks after the financial crisis, so not all the money created by the fed actually entered the U.S. economy. Therefore, it’s not fair to use the Fed’s dramatic monetary policy and subsequent small blip in price levels during the recession as evidence that we could simply print money for aid without affecting inflationScreen Shot 2014-04-05 at 10.25.44 PM

 

It seems surprising that a senior managing director and supposed global macroeconomic expert would make such a statement based on shaky evidence, so perhaps he is more privy to the more quantitative effects of QE on inflation than he lets on in his talk (he only has 15 minutes after all). Regardless, I would also contend that his strategy may also fail on practical terms as well.

Let’s assume that hypothetically the Fed liked this idea and wanted to enact this as part of its monetary policy. In order to make the donation, the Fed would have to enact open market operations in foreign countries by buying up bonds from central banks (or, if absent, the central government) in developing countries. While the Fed might expect that the banks would lend this money out to the citizens, thus stimulating the local economy, this may backfire given higher levels of corruption in these developing countries (corrupt and ineffective governments are often the reason why many countries remain in the “third world”). Many of the most impoverished countries do also score highest on indices of political corruption, such as Sudan and Haiti. These banks and governments may in some cases decide to shower the money upon themselves, leaving the citizens still impoverished. Furthermore, government debt in third world countries is likely to be far riskier than in developed countries, and the bonds are likely to become worthless. Therefore, it would be unlikely that the Fed could effectively channel foreign aid to developing countries and find the money reaching those that need it most.

Overall, it appears that there may be some large problems in Mr. Metcalfe’s solution to the foreign aid gap that would have to addressed before this could become feasible government policy.