Direct Monetary Financing, Quantitative Easing and Inflation

In the game, both QE and helicopter money have an effect on the credit rating of the country. This was reasoned because I assume that people are less likely to buy government debt if they think the government will effectively devalue (by printing money) to pay that debt off

This is an interesting point. Ofcourse one would be less willing to accept a 2% return on bonds if you have 5% inflation eating away the value of what you will be paid back. But this should be an effect of inflation, not a direct effect of QE. The more direct effect of QE is definitely to lower interest rates paid by the government because it pushes up the price of bonds. I am not aware of any economist that doubts that this is what happens at least in the short term. The empirical evidence for this is quite clear and the Bank of England accepts this as well in their explanation I linked earlier. Of course in reality we have had low inflation despite QE for a very long time now. That’s why governments have generally had to pay very little interest.

So my suggestion for the game would be that inflation increases interest paid on debt, while QE lowers it in the short term.

my own opinion is that infrastructure spending is likely the best possible type of QE/monetary expansion.

Infrastructure spending is Government spending. So if you want to be able to do that in the game (which I would love aswell) you have to implement Direct Monetary Financing, i.e. printing money for the treasury. It would fit the whole “Zimbabwe” theme of the game as well. Zimbabwe did not use QE or helicopter money. They printed money for the treasury.

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very very interesting. I definitely need to take a look at my model for this.

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I’ve been looking at the code and data a bit, and was looking into making a link between inflation and credit ratings (which are basically interest rates, as expressed in the game), and wanted to add a link here.
Currently the code that works out what credit ratings should be checks if any ‘money-printing’ policies are in place (basically QE or helicopter money), and if they do, it then increases the debt risk and worsens the credit rating.

I was thinking that this is simply a hacky way of bypassing the inflation simulation.

Both QE and Helicopter money increase inflation already, so I’m thinking about scrapping this hard coded link between those policies and the credit rating, and instead just having a link between inflation and credit ratings. I’m thinking that:

  1. This simplifies the code and makes it more flexible to equation changes.
  2. There should be a general purpose link from inflation to credit ratings, regardless of the source of that inflation (could be strong unions pushing for wage rises as well).

Which sounds sensible to me, but then I still cannot get my head around this idea that QE reduces interest on government debt. I think we are debating two conflicting forces here:

  • The effect of ‘cheap money’ pushing down interest rates in general (for everyone)
  • The effect on the perceived stability and credit-worthiness of a government

I’m reckoning that the second outweighs the first, but I guess it could be that this depends on how much QE there is.

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I think this is a reasonable first change to make. Though there might be a problem here with conflating “credit rating” and “interest rate on govt debt”. I am not sure what other effects the credit rating has in the game. I think it can cause an adverse event “debt crisis”? But you have to consider that high inflation does not mean a country is more likely to default. It simply means that creditors will expect a higher nominal return, because the money they get back will be worth less. It does not mean the government is at risk of default. In fact inflation tends to make it EASIER for governments to pay back debt, since it reduces the value of that debt.

Now to the effect of ‘cheap money’ under QE pushing down interest rates in general:

For the private economy, this should boost GDP, because it is eaiser to borrow money for investments. As far as I know this is already implemented, so no change needed here.

But for governments it also makes it cheaper to borrow. So QE should definitely reduce interest rates paid by the government.

I know you think there must be some kind of catch with QE. And there is the catch that it can cause inflation. But as long as inflation remains low, QE is relatively unproblematic in terms of stability of the economic system. I think you should trust the wisdom of central bankers around the world on this one, who have been relying on this heavily for a good reason.

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True. I see how it works, I get the impression that this is one of those things where the policy works fine…until it suddenly doesn’t, and a tipping point is reached. Unfortunately, true though such systems are, they make for a nightmare game design, because generally speaking in games you need to ensure a player has a lot of warning that something bad is likely to happen before you punish them :smiley:

Currently the ONLY purpose in the game of credit ratings is to indicate changes to the interest rate on government debt, so in gameplay terms the two systems are basically the same.

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Currently the ONLY purpose in the game of credit ratings is to indicate changes to the interest rate on government debt, so in gameplay terms the two systems are basically the same.

Great! No problem then.

generally speaking in games you need to ensure a player has a lot of warning that something bad is likely to happen before you punish them

The warning should be that inflation is getting dangerously high! In fact that is already something I look out for when playing the game and that is exactly what central banks always watch. For them it is always a game of balancing the growth of gdp with the need to control inflation around 2%. This is called the “dual mandate”. I would love to have a game where you have to do this.

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What if the catch is that it’s more efficient (in terms of GDP/inflation ratio) than helicopter money, but a lot less popular? Effective policy vs popular policy is uncommon in D4 but the gameplay fully supports it.

Edit: Generally, D4 is a game about governance, not politics. So polices tend to be balanced based on their effects, rather than on net popularity or capital cost.

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I think you are right that the catch of QE is not that something is lost compared to where no measure is put in place, but the opportunity cost of implementing some other measure such as helicopter money.

No idea whether QE is more efficient in terms of GDP/inflation as you suggest.

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Another vote for Direct Monetary Financing! I feel that QE is a very capitalist money policy, while helicopter money is neutral, and DMF is the socialist version. I think adding it would give better balance.

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Here’s a good paper on how Canada successfully used DMF from the 1930s to the 1970s.

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i have an idea for the deflation issue, instead of having separate inflation/deflation combine them into one stat, if lower than 50% then you get inflation, if higher than 50 deflation, 50 is equilibrium.

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Surely thats only true for people who are domestic holders of the debt? So someone who lends the government £10 and expects to get their £10 back doesn’t care as much as someone who lent the government £10worth of dollars, and will expect the current exchange rate value of $10 back?
(depending how such debts are structured and financed… I am no expert in this matter).

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This would be generally correct, however there do exist some skewed wealth contracts IRL that create the scenarios Maphylius described, where the currency is outright stated in the deal, and when inflation hits it’s too late to modify the deal to be through another currency/ resource.

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It seems crazy to me that foreign investors lend money on such terms, but clearly they do!

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It is odd that it is currently possible to hand out money to citizens, but not to use it for public spending

Probably because it’s not something that central banks are willing to do.

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Probably because it’s not something that central banks are willing to do.

Canada and France have both used it previously. And during covid in particular, many countries seriously considered it.

I’d wager it’s been used more frequently than helicopter money.

Besides, there are several policies in the game that are not something any countries have ever done, but that’s part of what makes a game fun.

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ask yourself why? they do not aim to profit from their investment, at least not directly, keep in mind that most of the US debt will probably never be paid, or if it does get paid then it will be at a lower interest rate and negotiated down, these investors seek power and influence, not to directly make money, but to instead gain favor with the ruling party and use that favor to make money.

money may not even be the reason they want influence, maybe they have ideological motives?
you have to think about this within the context of the current political situation, not from a purely economic perspective.

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If my country has a strong government and economy, why should my interest ever be high? Or why can’t I just issue local debt?

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Because game design :relieved:

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Can I just add my voice to support what @Maphylius said in this thread that QE should reduce interest rates (as also argued for separately in this thread: Quantitative Easing Suggestion).

If it doesn’t already, then for balance interest rates could increase inflation (& it makes sense for inflation to be a major economic factor that the player should need to keep an eye on - as in real life - which means benefits as well as costs.)

If @cliffski feels more of a downside is needed, then QE could cost more political capital and could severely reduce happiness of socialists and middle income (because of the opportunity cost of not doing helicopter money & so putting more cash in people’s pockets). Any chance of looking again at this?

Also agree that DMF makes sense as a policy: if you can print money for citizens then you can do so for the treasury too.

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