Quantitative Easing 2. Some Economists Weigh In.

[Integral]

@xarthas: You are deliberately confusing an accounting identity with subjective valuation by individuals as the basis of trade. It's good to keep those two concepts distinct.

MV=PQ is a tautology. Well, technically it's BmV = PQ where B is the monetary base and m is the (time-varying) money multiplier which nets you the monetary aggregate (M1, M2, M3, whatever) that you're interested in. The point is the same.

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Whomp has a more pertinent objection: that bank reserves at the Fed are already impossibly swollen (about $1T, if I recall correctly) and that QEII will just add to excess reserves and not move the broader monetary aggregates, the price level, or the level of nominal spending. It's a good caution and the point is well taken.

 

[Cutlass]

Well, it depends what type of inflation you mean. In the colloquial sense, I'm kinda worried over the 2-3 year timeframe, in that people's spending power might decrease as the cost of inelastic goods rises.

It's what the normal person thinks of as 'inflation', though not what economists think of.

TBH, QE kinda spooks me. It's very macro, and seems to be very far removed from what the actual problem is.

Yeah, I'm more or less with the article Robert Reich had in the paper Sunday. Monetary policy, and add tax cuts to that, are an approach I have no faith in under the current circumstances. They just don't address the problem.

 

[Gigaz]

http://www.huffingtonpost.com/2010/11/05/fed-bernanke_n_779393.html

Germany, China and Brazil don't like the Quantitative Easing. Japan too, I believe, but they aren't mentioned.

 

[Cutlass]

In other words, they think a weak dollar to help exports hurts their exports

 

[innonimatu]

With $1 trillion in excess bank reserves this will not influence institutions to lend. All it will do is sit idle on the Fed's liability side and banks asset side. In other words, Hoenig is right and the Fed will eventually regret this decision.

Why would they want to influence institutions to lend? There is still excess debt in risk of default!
A debt problem cannot ever be solved merely by creating more debt. Especially as there is no mechanism to force lenders to favor business loans over any other application for their money. It was quite clear, during the time of the "excess liquidity", that they were not favouring its application into capital goods inside your country.
Keynesiasism is fine, but it assumes that it is being applied in an economy with a "controlled border". Which is not the case currently, on either side of the Atlantic, causing many of the countries which are trying to spend their way out of the crisis to be just digging their hole deeper.

Playing around with the financial system does not solve economic crisis. It is necessary to intervene in order to prevent further degradation, but solving the problems requires addressing its root causes. The bankers and paper traders, greedy bastards that they are, will always chase return, and investment into productive activities in "developed" economies simply isn't being favored. The trade policies of these developed economies (with a few exceptions) caused that, and it will remain so until those are revised.

 

[Cutlass]

They want businesses to borrow, so they can invest and create jobs.

 

[innonimatu]

They want businesses to borrow, so they can invest and create jobs.

Business would borrow it if had a profitable business model to invest on. The last widespread "profitable" business model has been to build unnecessary housing.
Business would be far better helped by creating an environment where it could sell its products profitably.
But for that to happen governments would first have to cease believing the twin fallacies of "free trade" and "monopolies are bad".

 

[Cutlass]

How is "monopolies are bad" true? I've never seen a valid argument for monopolies. In fact, the more you get away from them the better off everyone is.

 

[Integral]

I found this far more amusing than I should have.

The original Fed statement:

Information received since the Federal Open Market Committee met in September confirms that the pace of recovery in output and employment continues to be slow. Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising, though less rapidly than earlier in the year, while investment in nonresidential structures continues to be weak. Employers remain reluctant to add to payrolls. Housing starts continue to be depressed. Longer-term inflation expectations have remained stable, but measures of underlying inflation have trended lower in recent quarters.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate. Although the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, progress toward its objectives has been disappointingly slow.

To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to expand its holdings of securities. The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period. The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh. Voting against the policy was Thomas M. Hoenig. Mr. Hoenig believed the risks of additional securities purchases outweighed the benefits.Mr. Hoenig also was concerned that this continued high level of monetary accommodation increased the risks of future financial imbalances and, over time, would cause an increase in long-term inflation expectations that could destabilize the economy.

The Fed statement, translated into Plain English:

The economy still sucks. People are spending a little bit more, but they're stretched thin: One in 10 workers can't find a job, wages are basically flat, home prices are way down and nobody can get a loan. Companies are buying more stuff, for now, but they're not building new factories or offices. Nobody's hiring. Nobody's building. Inflation has gone from low to super low.

The Fed has two main jobs: Keep unemployment low and prices stable. At the moment, as you may have heard, unemployment is really high. And inflation is so low that it's making us nervous. We keep saying that unemployment's going to fall. And it keeps not falling.

So to give the economy a kick in the a**—and to pump up inflation a little bit—we decided to go on a shopping spree. First of all, we're going to keep buying new stuff when our old investments pay off. Second—and this is the big news for today—we're going to create $600 billion out of thin air and use it over the next eight months to buy bonds from the federal government. We hope this will make interest rates go so low that people will borrow and spend more money, and companies will start hiring. By the way, this is an experiment, and we don't really know how it's going to work out. We reserve the right to change our plans at any time.

Of course, we'll continue our policy of letting banks borrow money for free. If you're worried this is going increase inflation and destroy the dollar, please reread everything we've said to this point. We plan to keep rates near zero for as long as it takes, but we won't tell you how long that is. In the meantime, we'll keep an eye on things.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh. Voting against the policy was Thomas M. Hoenig. He's the president of the Kansas City Fed, and he's voted against Fed policy at every one of our meetings this year. He thinks this whole creating-$600-billion-out-of-thin-air thing is going to do more harm than good.He also thinks that all this money we've pumped into the economy could inflate another bubble and create widespread worries about inflation. That could lead us right into another crisis.

 

[Cutlass]

Who did the translation?

 

[Integral]

I found it over at NPR; the translation was from Slate.

 

[Cutlass]

Are you still a monetarist?

 

[Integral]

Are you still a monetarist?

I'm a quasi-monetarist. The main hallmark of Old Monetarism was that velocity was stable in the long run, so setting money growth to a stable path would ensure that nominal spending remained on a stable path. An implication is that monetary policy should stick to a money supply rule and ignore recessions, because intervention would do more harm than good. I certainly don't subscribe to that view.

The central bank should be targeting some nominal aggregate, but the money stock isn't it. Inflation is one answer, which Canada, Australia, New Zealand, and the United Kingdom have used to great effect. The problem with inflation targeting is that it fails precisely when you need it most, in deep recessions. A price level target would be more sensible, so that the bank would be able to credibly commit to make up for any temporary under-shooting caused by the zero lower bound. A nominal spending target would be even more sensible, but that would be a a fairly radical change and it would be extremely difficult to frame a nominal spending target in the usual interest-rate language.

However, like monetarists, I like to view aggregate demand shocks (er, recessions) in terms of the supply and demand for money, as opposed to a Keynesian-type analysis which would focus on specific bits of the C+I+G+NX equation.

Here's a practical example. Paul Krugman likes to talk about this in interest-rate language as an excess of desired saving over desired investment, and to get to a good equilibrium (i.e., out of this recession) the central bank needs to push the real interest rate down until the desired quantity of investment clears with the desired quantity of savings. Quasi-monetarists see things in terms of an excess money demand problem: the quantity of desired money holdings outstripped the supply of money, and the central bank needs to increase the supply of base money until the money market clears. This, along with a bit of muscle from the Fed (negative IOR, explicit price level target) will as a side effect force down the real interest rate until the savings market clears. The "paradox of thrift" is really a paradox of hoarding, and the Fed can mitigate that by printing new money to satisfy the hoarders' increased demand for money.

It's "monetarism" in the sense that it views nominal, monetary problems as having real effects, but "quasi" in the sense that it rejects the old-style focus on particular monetary aggregates and money-growth rules in favor of price-level targets or inflation/Taylor rules.

It's weird to write all this and yet still acknowledge that my basic model for thinking about the conduct of central banks is the New Keynesian IS/PC model plus a modified Taylor Rule.

 

[Cutlass]

How do you deal with money for speculation instead of investment or consumption?

 

[Integral]

How do you deal with money for speculation instead of investment or consumption?

Bad investment.

Potentially a source of instability in asset markets (in the case of asset price speculation) or currency markets (particularly for developing countries in the case of currency speculation), but ultimately not central to the analysis. Speculative bubbles are hard to control and even harder to pop without damaging the rest of the economy.

 

[innonimatu]

How is "monopolies are bad" true? I've never seen a valid argument for monopolies. In fact, the more you get away from them the better off everyone is.

Efficiencies of scale and avoidance of unnecessary expenses for duplicate infrastructure or capital goods. That's the whole idea behind the notion of "natural monopolies".

Aside from that there's also the point, often forgotten, that a monopoly can choose to reinvest its profit in R&D as easily as it can choose to distribute it among stockholders. The classical argument against monopolies that they stifle innovation is fallacious, it assumes that profits will not be reinvested. Huge corporations well known as monopolies which destroyed rivals, from Standard Oil to IBM and AT&T, also did a lot of R&D and applied it. They even have another advantage which a larger group of smaller companies lack: they have the financial capacity to plan and support long-term investments with their own resources. The alternative is for industrial strategy to be at the mercy of the (increasingly, as we've been seeing) short-term interests of lenders.

 

[Cutlass]

Sure. Got that. My problem is that too much money, whether it comes from monetary policy or tax cuts, tends to head for speculation over anything worthwhile. Which makes it a poor policy choice.

 

[Integral]

Sure. Got that. My problem is that too much money, whether it comes from monetary policy or tax cuts, tends to head for speculation over anything worthwhile. Which makes it a poor policy choice.

I understand that fear. Of course, by adjusting the supply of money I also mean one can adjust it down as well as up. You expand the monetary base in recessions and contract it in expansions. We fortunately have a few tools -- TIPS markets, CPI futures markets -- which allow us to proxy future inflation and hence whether or not the money supply is growing too quickly or too slowly.

 

[EnglishEdward]

A debt problem cannot ever be solved merely by creating more debt.

Good post.

I am not an economist, but it seems to me that the US and UK governmernts are merely using quantitive easing in the 21th centrury as a disguised method of electronically printing money like the Weimar republic did with printed money in the 120th century.

This means that the value of the debt will be eroded by inflation, and that everybody else's assets are devalued to redistribute it to the so called bankers etc.

Especially as there is no mechanism to force lenders to favor business loans over any other application for their money. It was quite clear, during the time of the "excess liquidity", that they were not favouring its application into capital goods inside your country.

Quite so.

Fossil fuels are rapidly being exhausted. There is an urgent need to invest in alternative forms of energy production and transport. But this is not happening as fast as needed. Now the banks will claim that the business cases don't add up. The truth is that the investment banks are no longer capable of undertaking long term investments, because they have become corporately morally corrupted by the ability to make short term profits this year by for example borowing money from a central bank at 0.5% and lending it out on credit cards at 17.5% and individually morally corrupted by getting a million pound bonus this financial year for doing exactly just that.

This of course does not stop the banks from using the recession to try to cut the (actually below national average) pay of the junior clerks in high street banks who try to provide good service to customers, and to withdraw established services such as paper cheques (of value to the elderly, who are understably not anti-internet fraud experts).


Most of the money in UK alternative energy is in wind power, because this offers a faster rate of return than nuclear and most of the investment here is by French and German power companies from retained profits or by Saudi investors who prefer to avoid usury.

It would have been far more efficient for the Bank of England to have creditted a billion or two (of this quantitive easing) into power and transport company subsidiaries specifically tasked with developing alternative power and transport.

Playing around with the financial system does not solve economic crisis. It is necessary to intervene in order to prevent further degradation, but solving the problems requires addressing its root causes. The bankers and paper traders, greedy bastards that they are, will always chase return, and investment into productive activities in "developed" economies simply isn't being favored. The trade policies of these developed economies (with a few exceptions) caused that, and it will remain so until those are revised.

I fear that this looks like continuing until the whole system collapses.

 

[Cutlass]

Almost no one sees any threat of inflation. It just isn't in the cards in the foreseeable future.

@ Integral, how do you address the concern of money flowing over borders rather than doing what is wanted?