QE for Growth? Bullshit

A few years back a really small book attracted my attention because of its title. I know, that is the way it usually happens. But this one title was really special: On bullshit, by Harry G. Frankfurt, moral philosopher, Professor Emeritus of Philosophy at Princeton University (Princeton University press, 2003). Obviously, a must-buy, must-read, must try to understand. After all, it is not everyday that such an expression is used by a moral philosopher, let alone become the subject matter of a book. The opening lines of the book read as follows:

“One of the most salient features of our culture is that there is so much bullshit. Everyone knows this. Each of us contributes his share. But we tend to take the situation for granted. Most people are rather confident of their ability to recognize bullshit and to avoid being taken in by it.”

Fast forward. In a recent post Simon Wren-Lewis, a colleague at Oxford, mentioned Professor Frankfurt and his work on bullshit. Now, before reading Professor Frankfurt, Emeritus at Princeton, I would have never thought of using such language myself. If in addition, however, Wren-Lewis uses the concept, I feel like I am free to use it myself: after all, if my majors do…

Today I would like to use the concept of bullshit within the context of contrasting theories about the effectiveness of Quantitative Easings (QE) in particular and of monetary policies in general. Here is the context. It is several years now that we are being told that growth is the rationale for QEs, first in the US and right now in the European Monetary Union (EMU). To be accurate, this is not a new refrain. We were always told that expansionary monetary policies, aiming at the reduction of the cost of borrowing, would stimulate growth through increased demand for firms’ investments. QE is only the latest version of an expansionary monetary policy, but the reasoning remains intact.

I have always been very sceptical of the actual effectiveness of such mechanism. In more philosophical language, I believe this is bullshit. Generations of my students can testify to that. Let me reproduce here, briefly, the way I represent the effects of monetary expansions on expenditures in investment goods:

I= I(E) – ki,               where:

I = Demand for investment goods by firms

E = Expectations by firms about future demand for the goods they produce

k = Reactivity of firms demand for investment goods to market interest rates

i = market interest rates

This is what I submit to the attention of my students and that I define “an honest representation of the investment demand function.” Honest in what sense? In the simple sense that I do not believe it to be a serious representation of the way firms react to macro changes, but since much has been written about the importance of market interest rates, I want my students to see the full formulation. Still, I warn them that Expectations are what I believe to be the real driver of investment demand. The point is as follows. Of course, anybody prefers to get into debt at a lower, rather than higher interest rate. But is the interest rate level the most important factor in the investment decision? A firm considering any level of expenditures towards increasing its productive capacity (that is, investing), will primarily pay attention to business conditions or to the level of interest rates?

Example. Suppose you are in the middle of a recession, you cannot see any way out soon, but your lender offers you favourable rates (‘favourable’ by historical standards, of course, since you have no other criterion to assess what a ‘favourable interest rate’ could be). Would you borrow to expand your production capacity? [I would not] Alternatively: suppose market rates are ‘high’ (again, by historical standards), but you expect that demand for your product will be picking up in the near future. Again: Would you borrow to expand your production capacity? [I would].

Enough with models and examples let those who make investment decisions talk. Here is what they say as quoted by the Financial Times in a Chris Bryant and Claire Jones September 7 Financial Times article, “ECB quantitative easing: Failure to spark”.

Bryant and Jones:

When Siemens revealed a €200m investment in a new wind turbine plant at Cuxhaven, Germany’s North Sea coast, last month, it was hard to know who had more reason to cheer: the 1,000 people who will be employed at the facility –or the European Central Bank


[You can feel here the presumption that monetary expansions lead investment]

Ralf Thomas, Siemens chief financial officer:

Those [jobs] were not created because interest rates are low. Investments are driven far more by assumptions around growth, potential profit and technological barriers to entry, rather than movements in interest rates… We don’t decide to spend more just because interest rates are lower for a couple of years.

Kurt Bock, chief executive of BASF:

There is no stimulation from cheap money to invest more. We orientate [our spending] towards growth prospects…and in Europe those growth prospects are modest.

Bryant and Jones:

This mood reflects a broader debate among central bankers about just how much influence their policies –such as setting low interest rate- can have on investment decisions.

Mario Draghi:

I would say that our accommodative monetary policy is being passed through to the rest of the economy.

[I expect some comments about the fact that, unlike the large ones I have cited, small and medium enterprises actually are sensitive to changes in interest rates. Since I have no patience whatsoever with the supposed virtues of SMEs, and I am short on time, I have to ask the interested reader to go and look at data about investment by SME in Italy since 2007, Italy being host to a large number of such enterprises. You will find that investment expenditure has fallen along with interest rates! ]

In the way of a conclusion

It is painfully evident that central bankers do not pay attention to what even very senior business people tell them. Better: they do not hear voices coming from the real economy, the one where goods are produced and consumed, where investment and saving decisions are being made, where the future of an economy is built.

But that is not the crucial point right now. The crucial point is that Professor Frankfurt is right: there is a lot of bullshit going around. And most of us are confident that we can spot it. Not so, we have to keep our

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