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Will Printing Money Do It?

As recession deepens in the euro zone and US growth remains tepid, western central bankers have in effect announced their intention to print money as long as it takes for growth to return. The critics of this Keynesian solution are seeing red. Republicans fret that jump-starting job creation, as US Fed chairman Ben Bernanke proposes to do, could improve the re-election prospects for Barack Obama. Head of German Bundesbank considers it a devilish policy that would burn Germany along with the euro zone in the fire of inflation.

But what happens if inflation is not ignited, and nor is the engine of job-creation lit? The answer to this conundrum will determine the health of the world economy for years to come.

The Fed’s policy of Quantative Easing (QE3) is effectively a plan to print $40 billion each month to buy mortgage-backed securities for an indefinite period. The resulting lowering of mortgage rates is expected to revive the housing market and, along with it, construction industry jobs and household wealth. As Bernanke put it, “We’re looking for ongoing, sustained improvement in the labour market.”

Despite criticism, Bernanke certainly has the authority to take this extreme measure as the Fed’s mission is “to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates”.

The idea behind QE3 is that uncertainty about fiscal policy since 2008 has depressed job creation by 2 per cent. A similar desire to end uncertainty forced the European Central Bank to promise unlimited backing to shore up national bonds. The euro zone economy shrank 0.2 per cent in the second quarter compared to the previous quarter. Job losses, too, accelerated at the fastest pace since last year reaching a record rate of 11.2 per cent in June. After unsuccessful attempts at saving the euro through repeated bailouts, and pursuing an austerity policy, ECB’s Mario Draghi has promised to indefinitely buy debt from euro zone countries like Spain and Italy that are threatened with unsustainable rise in bond yield. Troubled countries have been buoyed by the promise of ECB support but they haven’t yet asked for help, worried perhaps by new conditionalities.

How long will the money taps remain open? One of the Fed’s bankers, Charles Evans, of the Federal Reserve Bank of Chicago, recommended that the Fed pledge to keep rates near zero until unemployment is down to 7 per cent or inflation has risen to 3 per cent. It is not clear what happens if near-zero rates do not inspire bankers to risk offering long-term mortgages, or if the housing market does not take off. Neither is there certainty that the ECB can keep its promise if countries start backsliding on reform. If investors keep sitting on their pile of cash, despairing about not finding customers, there may be no inflation — but there won’t be any rise in employment either.

In their determination to jump-start the economy through stimulus spending, the central bankers may not have factored in the challenge of structural changes taking place in the labour market. Although the manufacturing industry, discouraged by rising wages in China, has begun to return to the US, job creation has been tepid. The new manufacturing relies more on automation and robots supervised by only a handful of engineers.

The fact is that unemployment is not just an American or an European problem; it is rising in China as well. For a long time China’s low-cost labour has been held responsible for disappearing western jobs. The latest data shows that manufacturing employment in China peaked in 1996.

While China’s manufacturing output in 2008 was 70 per cent greater than it was in 1996, over the same period, employment in the sector dropped by more than 25 per cent. Productivity from increasing automation rather than labour shortages could provide the explanation. Further indirect evidence comes from analysts showing that while wages are rising in China, so too is unemployment. This is because available skills do not meet the demand for high-tech manufacturing — exactly the same reason why many US manufacturing jobs remain unfilled.

Given the rather dim prospect of fiscal stimulus to financial institutions succeeding in creating jobs and increasing aggregate demand, central bankers may one day be forced to consider a remedy that some economists have long suggested for boosting consumption: simply hand over cash to individual citizens as tax rebates or vouchers for goods and services.

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