Quantitative easing

by on March 19, 2009 at 8:22 am in Economics | Permalink

Bernanke will do it.  I'm sitting in an airport, so here is a very quick take.  It is cheaper and quicker than fiscal stimulus; this should have been our first move.  It is more likely to work.  There are two effects: lowering long-term interest rates and the helicopter drop of the cash.  It belies previous talk of a liquidity trap.  It does not address most of the underlying problems in the real economy and as you know I see the "sectoral shift" element of this downturn as very much underrated.  In that sense don't expect too much.  It shows that at the limit fiscal and monetary policy blur together.  The more the Fed takes on its balance sheet, the more the long-run independence of the central bank is damaged.  Monetizing so much government debt is what Third World nations do.  Draining the new money from the system will someday be a problem.  It may introduce a round of "beggar-thy-neighbor," central bank-engineered currency depreciations.  "Operation Twist," from the 1960s swapped short- for long-term assets but did not seem incredibly effective, although it was done under very different circumstances.  Trillion is the new billion.  If this fails the U.S. economy, and the stock market, will test new bottoms.  The most articulate advocate of quantitative easing is Scott Sumner.

unseen March 19, 2009 at 8:53 am

It will fail because it does not address the central reason for the slowdown. One of demand destruction brought around by high prices and low wages. What we are seeing is the otherside of outsourcing and runaway mergers. Supply got destroyed by merges raising prices at the same time that wages were capped due to outsourcing and illegal immigration. Basically prices must fall and/or wages must go up before we will see a major uptick in the economy. Throwing money at the problem will work short term but the underlying problem remains. business must lower their profit margins on goods and services before the economy can fully recover. The record profits of the last 2-3 years was flagging the coming recession.

floccina March 19, 2009 at 9:04 am

did not seem incredibly effective

What does that mean?

MostlyAPragmatist March 19, 2009 at 9:22 am

It does not address most of the underlying problems in the real economy and as you know I see the “sectoral shift” element of this downturn as very much underrated.

Krugman also wonders about this. See here. He also doesn’t answer will take the place of housing, but he speculates that our trade deficit will have to decrease which means the sectoral shifts in the US that could lead to recovery are dependent on foreign economies recovering as well.

Tadhgin March 19, 2009 at 9:55 am

Sitting in an airport… waiting for the helicopter

odograph March 19, 2009 at 10:07 am

Why now?

E. Barandiaran March 19, 2009 at 10:53 am

Anyone interested in learning a little else about quantitative easing can look at
http://www.ft.com/cms/s/0/8ada2ad4-f3b9-11dd-9c4b-0000779fd2ac.html
Now let me make some comments on quantitative easing and Tyler’s post. Quantitative easing is usually known as inflationary finance of fiscal deficits. It has been known for a long time (200 hundred years?) and it has been used for all sorts of governments that need to finance some expenditure but can neither collect taxes nor borrow. It doesn’t matter what the government gives the central bank in exchange for cash (Note: some people may say that in this particular instance quantitative easing is different from inflationary finance of fiscal deficits to the extent that the Fed may also buy private securities; well, any private security or asset that it will buy has no market so what the Fed is doing is implementing a particular government policy of subsidizing some debtors or owners, that is, is financing a government expenditure). It has been called inflationary finance because it finances the deficit by increasing prices of consumption goods, which in turn means that cash holdings lose value (in other words, through inflation). Decades ago PerĂ³n was a very articulate advocate of quantitative easing, and today Robert Mugabe is the most articulate advocate–he can deliver the cash to sellers of all kinds of goods and services.
In the current situation the big gamble is whether quantitative easing will increase demand for goods and services without rising prices (the idea of the liquidity trap, that is, an excess demand for cash that is met by an increasing supply so people do not have to save to increase their cash holdings which in turn triggers a deflationary process) or it will increase some prices (that is, there was no excess demand for cash and people spend the increase in the supply of cash to buy assets, in particular assets that can protect them from the expectation of an increase in inflation). The impact of yesterday’s announcement on exchange rates suggests that many people believe that there is no excess demand for cash (with respect to the euro, the dolar depreciated by 10% in the last 10 days, mostly in the last 24 hours). In addition, the price of gold has increased sharply since the announcement. It’s too early, however, to conclude that it will fail to increase the aggregate demand for goods and services because there is too much noise in both the economy and government. Unfortunately, given Bernanke’s position, this may be the worst outcome–he may intend to repeat the dose.
If yesterday’s dose of quantitative easing succeeds, contrary to what Tyler says, there will be no inflationary problem even in the long run. Apparently Tyler thinks that if quantitative easing succeeds, people will reduce their cash holdings suddenly, but most likely people will do it gradually if at all and the Fed will never have to drain the new money from the system.

mulp March 19, 2009 at 11:22 am

Interesting take: “…this should have been our first move…Monetizing … government debt is what Third World nations do”

Jason (the commenter) March 19, 2009 at 12:23 pm

Tyler must have missed the news that the US government is buying this debt just as China is trying to sell it. Wonder how that changes his calculations?

Gabe March 19, 2009 at 1:26 pm

in his appearance before Congress, Bernanke revealed with a single word who really runs the United States:

Senator Sanders: “Will you tell the American people to whom you lent $2.2 trillion of their dollars?”

Bernanke: “No”
No?

Indeed, Bernanke and Treasury refuse to provide this information even confidentially and off-the-record to Congress. And the official overseer of the TARP bailout program can’t even get the information of where all the bailout money is going. See also this.

With his single word “no”, Bernanke revealed that Congress is impotent and out of the loop. In other words, Congress doesn’t really run the country in the core area of business, finance and the economy. The financial giants and their servants at the Fed and Treasury do.

Lord March 19, 2009 at 3:09 pm

It won’t be inflationary as long as it merely replaces ongoing losses. It will prevent deflation from taking hold. Lowering the overvalued dollar will help. Sectoral shifts occur with such frequency, it is nothing the economy doesn’t have to deal with all the time.

monopolyman March 19, 2009 at 5:29 pm

Mark Dude, devaluing the money is not the easy lifeline you think it is instead of banks trying to get their money back the “hard way”. Devaluing the money screws all the responsible people, companies, states and countries that saved their money in dollars. It is this money that is loaned to the economy to make it grow. So now that the fed is in the process of stealing my money, I and every other responsible screwed party will never, ever, loan money to the USA again. This administration has destroyed the econmy. Not to mention all those baby boomers who will get their substantional fixed pensions in monopoly money. The clowns in Washington have destroyed the USA. Damn, I was hopping to to be vaporaized in a radioctive flash when the end came. Instead, I get to starve and watch my family die a slow, painful death. Hope and Change!

Scott Sumner March 19, 2009 at 6:12 pm

Tyler, Thanks for the mention. I should say that the policies I have advocated most forcefully have been to have the Fed put a penalty charge (negative interest rate) on excess reserves, and set an explicit target path for NGDP growth. But I have also advocated quantitative easing, and this is better than nothing. But the other actions would be far more effective, and indeed would probably make it so that quantitative easing was not necessary. Many of your commenters are worried about high inflation. I am worried about low inflation. Even after a slight bump up, today’s indexed bond market shows only 0.8% inflation expectations over the next five years. My hunch is the rate will be a bit higher, but we are not looking at hyperinflation. Japan injected massive amounts of reserves years ago, and their price level is still falling. (BTW, in Mankiw’s blog today he mentioned that a “clever grad student” there just discovered the idea of negative interest on money. 80 years after Gesell.)

Jason (the commenter) March 19, 2009 at 7:32 pm

It won’t be inflationary as long as it merely replaces ongoing losses.

But there are no losses. The US government is purchasing agency debt it backs and treasuries.

The money is probably going to go to foreign governments, who want to sell their secret dollar holdings to buy commodities throughout the world. So inflation wise the results should be the same as if the US government printed and spent a trillion dollars on copper mines and oil fields for other countries. Think of it in those terms.

The only positive is that it lets the US government hide the fact that foreign governments are selling its debt.

Doc Merlin March 20, 2009 at 3:44 am

Alright folks, welcome to stagflation! Delicious, delicious stagflation.
Most examples I have ever seen of quantitative easing used to try to end deflationary recession during a period of high taxes and high regulatory burden, it just resulted in stagflation.
This is going to sound strange, but I think in this case the Austrians are correct.

Lord March 20, 2009 at 5:29 pm

“there are no losses”

Some 20-25 trillion in wealth gone domestically and 40-45 trillion worldwide don’t count? Tell that to investors in Bear Stearns and Lehmans, AIG and Citigroup. Tell that to investors with Madoff. This is just being used to limit those losses. Wealth translates to money only through income, but that is far from nothing. The reason the increase in money supply hasn’t created any inflation is credit is vanishing faster as well as velocity diminishing. This is a modest start, but it will take more to cover those losses. It does depend on what is done with it though. Selling the dollar would be in our interest as it makes us more competitive while lowering our debt burden. If they don’t sell the dollar it will just flow into domestic assets. It’s a win all around for us, not so much so for foreigners who then have to reinvest at lower returns.

Lord March 22, 2009 at 10:13 am

Money is fungible and will find its way there anyway by making all assets more valuable because it serves to support the market at the level it was operating. Deflation is a terrible thing.

It is in our interest to generate income and that is what it does. That is far more important than debt because it makes less borrowing necessary. The free lunch of ever increasing borrowing was never in our interest and never made us better off despite the wishes of the right. The world economy is rebalancing and that is to be welcomed, not disdained.

GT April 2, 2009 at 5:18 am

Has anyone read about the alternative solutions to the crisis as proposed by the American Monetary Institute? In any case, it appears to me that by having the FED create more money for the banking industry is unlikely to generate any inflation right now considering the huge deflationary pressures on the money supply at the moment. Any one take a look at the recent inflation rate (less than 1% and expected to turn negative soon)-www.inflationdata.com.

However, I think there is a larger issue being missed here. The fact that our society is even dependent on commercial banks for the availability of money in our system is in and of ITSELF a problem.

The solution as advocated by AMI (rather involved) would be to end fractional reserve banking altogether and have the ability to create money returned to the government. They used to call it the MONEY POWER back in 19th century until it became so enshrined within our institutions as to become almost invisible.

I wish solutions would be more widely discussed on these forums instead of the constant hand-wringing that is typically seen without any viable solutions being proposed.

Take a look at a reasonable solution to this problem at http://www.monetary.org, read “The Lost Science of Money” and spread the word.

Cheers.

James June 14, 2009 at 12:13 pm

It does work. Just look at Japan!

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