More Liquidity?

The holy grail of macroeconomics is to integrate the real and monetary sides of economics. One needs a good balance between the two: one shouldn’t be too much on one side.

In a recent article, Monetary Policy in a Post-Crisis World: Beyond the Taylor Rule for INET, Perry Mehrling correctly identifies the flow of funds approach and Morris Copeland. He says:

Maybe time to look back at Copeland, reconstructing his money flow approach for the modern world? That’s where I’m placing my bet.

Although, his article seems right in lots of parts, it seems to identity purely monetary factors in identifying solutions to the problems of this world. Mehrling says:

From a money flow perspective, there are logically only three sources of funds for agents who find themselves in deficit on the goods and services account. They can dishoard (spend money balances), borrow, or sell some asset. In the argument sketched above, I have suggested that post-war institutional developments have followed a course emphasizing first dishoarding, then borrowing, and then selling, i.e. monetary liquidity, then funding liquidity, then market liquidity. All three are now in play, but the new one is market liquidity. That’s the one that broke in the global financial crisis, and that’s the one we need to fix in order to get the system working again.

While the first part of the argument is correct, I am not sure how fixing “liquidity” is needed to get the system working again. In my reading of Mehrling, he comes across as someone who stresses too much on the monetary side of things and this is another example of it. What do we need to do to fix liquidity exactly? More central bank asset purchases?

The solution to the problems of the world can come about if there is a coordinated fiscal expansion combined with balance of payments targets, to say the least. I am not sure how liquidity fits into this. After the financial crisis which started in 2007, this may have been the case: what was needed was providing liquidity to the financial system. In the U.S., Euro Area and the rest of the world, central banks have helped to provide liquidity to ease financial conditions. But right now—at least in the advanced world—interest rates are low and just lowering them further won’t help increase production. And the same with “liquidity”.

Hence I am unclear about Merhling’s solutions. It’s monetary hippyness.

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