Here’s the way the argument about monetary stimulus usually goes. A recession happens when too many people increase their savings at once. This takes money out of circulation, and this shortage of money produces additional, perverse incentives to hoard money. To break the cycle, you have to decrease the appeal of holding money – by producing inflation. Inflation causes money to lose value; the “safe” store of value is no longer safe. So the money goes back into circulation, to purchase goods and services, and a recovery ensues.
This, however, assumes that only cash and near-cash instruments can serve as stores of value. If you make cash less attractive to hold, but people remain pessimistic about their future prospects, they may not go out and spend. They may go searching for other stores of value that may be riskier than cash, but that are not subject to the dilutive effects of inflation: land, precious metals, etc.
These kinds of assets are substantially less-liquid than cash. But they are also substantially less-productive than other kinds of investments. Moving money from cash to speculation in land, for example, reduces the efficiency of the economy because cash can be more readily mobilized than land, and land – as such – doesn’t employ anybody or produce anything.
People and businesses are not hoarding cash because the returns on cash are so good. The returns on cash are terrible. That’s what it means to say that conventional monetary policy has run its course. Heck, at this point the returns on even longer term government debt are terrible; that suggests that unconventional monetary policy has fired a whole lot of bullets as well, without adequate effect.
The Fed could do more: expand the balance sheet even further, declare that it will continue to print money until unemployment drops to a certain level, etc. This might result in people reducing their savings, and increasing their spending in turn; it might result in businesses deploying their cash in productive investments rather than hoarding it. But it also might result in people taking their cash and buying physical gold; it might result in businesses shifting their cash balances into other currencies or putting a portion of it into instruments backed by physical commodities. Speculation-driven increases in the prices of food and energy – facilitated by cheap money and exacerbated by a declining dollar – might leave the average person in worse shape, financially, than before the additional monetary stimulus.
Moreover, speculative bubbles are economically destabilizing. The worst case scenario of continued monetary expansion is a modest increase in employment and a larger-than-expected spike in inflation, along with an outburst of speculative frenzy in the markets. The bubble would draw more and more resources out of the real economy into a relatively non-productive sector. Businesses would be reluctant to invest in such a volatile climate. Individuals would suffer from record high energy and food prices. And the Fed would be faced with a terrible choice of either sticking with the inflationary strategy – let’s assume unemployment is hovering around 8% at this point – in the face of all these warning signals, or throttling back, bursting the bubble, and throwing us into a new recession.
It’s not impossible. That scenario – collapsing dollar, weak and slow employment recovery, followed by a massive speculative bubble that wound up wrecking the real economy far worse than the prior recession – is exactly what happened in the 2000s. Because in that decade our government’s growth “strategy” consisted of war and encouraging people to sell each other houses at ever higher prices.
I understand the theory. I understand how it’s supposed to work, and that, all else being equal, there is a very clear relationship between inflation and employment. I have real questions about whether all else is equal in the real world.