Friday, March 25, 2016

Basic Income Guarantee: Deflation Cure

Japan just reported 0% inflation for January. If you follow economics, you know that governments are very scared of negative inflation (also called deflation). Without going into an in depth explanation, suffice it to say that deflation means prices for goods and services are dropping and economists tend to view such a phenomenon quite poorly, as it may indicate the economy is entering a recession (shrinking). Of course, a recession often triggers unemployment, which is obviously a bad thing.

In an attempt to fulfill its target of 2% inflation deemed healthy by some economists, the Bank of Japan (Japan's central bank) has recently implemented a negative interest rate policy, essentially charging banks for holding their money. This policy is a more extreme version of the zero interest rate policies implemented by many central banks during the Great Recession and is intended to encourage economic activity by making it more attractive for banks to loan out their money.


The problem is, despite these zero/negative interest rate policies, banks aren't really loaning out that much money. Banks and businesses are wary of making/taking on loans because they aren't confident consumer demand is sufficient to make such investments worthwhile (as indicated by lower-than-desired inflation).

Prices are failing to rise at a rate that would indicate to central banks that economies are healthy. Central bankers like those of the Federal Reserve in the US and the Bank of Japan believe that inflation of around 2% indicates the economy is growing at a rate that ensures the threat of a recession is low. While it is OK if inflation occasionally falls below the 2% target, what economists really fear is deflation. This indicates very low demand for goods and services in an economy and thus could be a sign a recession is on the way (or already happening).

Despite near-zero or negative interest rate policies implemented by central banks worldwide in an attempt to achieve their positive inflation targets, some economies are very close to deflationary realities. The recently reported 0% inflation in Japan for the month of January is just another sign that zero or negative interest rate policies designed to encourage economic activity have failed to do so in a way that would cause prices to rise at a healthy 2% rate.

The Bank for International Settlements (BIS), the so-called "bank for central banks," has issued a warning to central banks against the long-term use of negative interest rate policies. This is because if these policies don't work, central banks' perceived role as the agents of last resort to maintain economic stability may deteriorate. As of yet, we've conceived of no better way to maintain price stability and stave off recession than through the signals central banks send by altering interest rates.


Governments need to be proactive in addressing the issue of poor economic performance. They could pass laws requiring banks to lend out their money and thus ensure the effectiveness of central banks' zero/negative interest rate policies. Aside from the expected backlash from those who would argue it's unfair to force banks to lend out money they don't want to, it's unclear if such policies would even work. We have to remember that the entire reason why banks aren't lending out money in the first place is because business owners are wary there is sufficient demand in the economy to make such loans feasible. In short, we cannot even force the banks to loan out money if there are no businesses willing to take on that risk (not to mention it might be a bad idea as it would equate to banks losing money).

Enter basic income guarantee (BIG). An idea gaining attention worldwide, BIG is a policy of governments guaranteeing every citizen an income sufficient to cover their basic needs. Instead of worrying about the effectiveness of interest rate policies in getting banks to loan money to businesses who don't even want to take out loans, we can give money directly to our poorest citizens with the knowledge that they will likely spend all of it within a short period of time.

The problem in global economies right now is a lack of demand: by directly transferring cash to everyone who needs it, huge demand will be created instantaneously and maintained so long as people keep on receiving a guaranteed income.


With so much new guaranteed demand in the economy, businesses will be much more likely to invest in new workers and equipment. Economies will start growing in such a way that constantly pushes prices up at the healthy rate sought by central banks. Central banks will, in turn, be able to lift their interest rates back above zero/negative levels and thus regain a valuable tool in fighting off recession, all while avoiding the unknown consequences of long term negative interest rates. Finally, even if recession should come back, we will have implemented a policy that shields those who are/would become most vulnerable.

Further reading:
Economist's Journey to Life
Living Income Guaranteed

1 comment:

  1. Agreed. My version here: