The “neutrality” of money
There is an old concept in economics, largely obsolete, yet still tempting from time to time, called the classical dichotomy or the neutrality of money.
The idea is this: Because fiat money is intrinsically worthless (no one disputes this), nominal variables (like national debt, money supply, and interest rates) can be analyzed completely separately from real variables (like production, unemployment, and commodities).
Since Keynes, no one completely buys into this claim—clearly finance does actually matter—but I think many economists are tempted by the idea that it almost works, or works approximately, or works in the long run.
And when you’re talking about certain nominal variables, that might actually be true. For all I know, maybe the size of the money supply has no significant long-term effects on the real economy.
But what we seem to forget all too often is that one particular nominal variable is quite literally the most important factor in any economy. That is? The distribution of monetary assets. Money could be completely “neutral” in the classical sense, and yet the distribution of money would still be enormously important.
The total amount doesn’t matter, that much is clear. Imagine the Fed declaring, “Everyone must write 3 zeroes on the end of all their dollar bills and price schedules. Behold! Nominal GDP just increased a thousandfold!” As you might imagine, this would be incredibly stupid, because no one would actually be richer in real terms.
But this is not how the money supply works in real life. We never increase everyone’s supply of money simultaneously. Instead, we increase the supply in certain banks, or in certain industries; other people receive less, or none. This has a net effect on the distribution of money, which has an impact on the real economy.
This is what was wrong with the TARP bailout and quantitative easing. The problem is not that we printed money out of nowhere—we did, but so what?—but rather that we gave it all to rich people. If we had given it to the poor (e.g. in foreign aid) or the middle class (e.g. the homeowners who were underwater), the effect on the money distribution would have been quite different—and the effect on the real economy would have as well.
The key here is to realize that these programs didn’t just “increase the money supply” as economists will say. They also redistributed the money supply—so that each of us who didn’t get a bailout ends up with a smaller portion of the total supply. If they hadn’t done that, the bailout would have had absolutely no effect on the economy.