Incentives and Monetary Policy

Paul Krugman takes on his critics:

One quite common statement among the Austrianish horde is something along the lines of “It’s ridiculous to imagine, as Krugman does, that you can create real wealth by printing more pieces of paper.”

Well, it may be ridiculous, but it’s also true, under certain conditions — namely, when the economy is suffering from inadequate demand. And you don’t have to use highly abstruse reasoning to see this, either; all you need to do is think in terms of some kind of model, not necessarily of the mathematical kind.

In a way, things are even weirder than Krugman suggests. The hard money folks certainly believe in the real-world effects of incentives, and one way of looking at monetary policy is simply as a way of changing incentives. It changes the value of saving vs. spending money. It changes the likely value of real-world investment vs. holding government bonds. It changes inflation expectations, which in turn changes behavior. We can argue about the effect of all this—and we do!—but the proposition that printing money changes incentives, which has an effect on economic behavior and therefore an effect on wealth creation, really shouldn't be hard to believe intuitively.