Don’t flip out over QEII (repeating myself)

I'm not sure it will work, because it won't fix the housing market, may not restore the demands for wealth-elastic goods in a sustainable manner, may not restore the normal flow of credit to small businesses, may not lower subjective estimated risk premia, and may not fix the general disconnect between expectations and reality.  The effects on long-term interest rates are murky.  No one — and I mean no one — has a coherent story about how nominal stickiness of wages lies at the heart of our current dilemma.

Still, QEII may do some good.  Money matters, even if we don't always understand how or why, and excessively tight money has never done market-oriented economics any favors.  Think of QEII as a make-up for some earlier monetary policy mistakes.  Some of the relevant alternatives include a trade war with China or direct government employment of the unemployed and with what endgame?  QEII is not some terrifying burst of potential hyperinflation.  The TIPS market is forecasting in the range of two percent inflation and it's gone up — what — sixty basis points since August?  That's hardly the end of the Republic.  During the Reagan recovery, inflation never fell below four percent.  I've thought through "trigger models" of rapidly escalating inflation, but they don't scare me much.  The Fed simply needs to be ready to unload its heavy balance sheet without delay.

I do take seriously some of the more speculative criticisms, namely that QEII may set off bubbles in some emerging markets, or that it may break the euro (and that the euro would not otherwise break of its own accord).  Still, those hypotheses are far from established and it is difficult to believe that say three percent U.S. price inflation should bring international doom.  These factors also need to be weighed against the international and political economy costs of continued American economic stagnation.

I'm unhappy with claims that "we're not doing enough" and that therefore this is no test of the idea of monetary stimulus.  This is what QEII looks like, filtered through the American system of political checks and balances.  And if it looks small, compared to the size of our problems, well, monetary policy almost always looks small compared to its potential effects.  I'm willing to consider this a dispositive test and I am very curious to see the results.


"The Fed simply needs to be ready to unload its heavy balance sheet without delay."

Do we have any estimates on how much money the Fed can absorb once that selling starts? Does it stand to reason that it will be much less than what it provided?

No offense, but I have seen no evidence that you actually know what you are talking about. What trigger models have you considered? Why don't they scare you?

"excessively tight money has never done market-oriented economics any favors"

I really can't see who's tight ?

'excessively tight money has never done market-oriented economics any favors'

By adding 'excessively' you make this a tautology (though the use of 'economics' rather than 'the economy' is curious). And without that (if we were just talking about *tight* money) the claim would make no sense.

In any case, the very high level analysis totally ignores who benefits and who loses when these kinds of enormous distortions are introduced. Hayek, writing on inflation, noted that the benefits flowed to the recipients of the created money, since any inflation took a while to work its way through the system. In this context, I think looking at the graph of federal versus private sector salaries is enlightening: we may not see systemic inflation, but federal wages certainly look inflated. Would be interesting to estimate how much overall deflation we would have if federal wages had tracked private sector wages, as it seems they would have had to if we had balanced budgets rather than the Fed and Treasury financing the government.

Has anyone done empirical research on a possible link between inflationary central bank policies and the individual savings rate?

"Just" is one of the scariest words in the English language.

There is one aspect to QE2 that I haven't seen mooted anywhere.

Immigrants often have an advantage on the labor market of the host country over native workers, if the immigrants come from a country with a weaker currency. Take the case of an immigrant from a country with a currency worth a third of a US dollar, where for whatever reason prices haven't adjusted so costs are lower as well. An employer offers a job that pays $8 a dollar. For the native worker, he is being offered a job at $8 an hour. For the immigrant, he is being offered a $24 an hour job, or something reasonably close, as either/ or much of his pay will be remitted to relatives in the old country or he intends to work here in poverty for a few years then return with his savings.

Many immigrants therefore have a "carry trade" just like banks! Now its reasonable to suppose that QE2 could destroy the value of the dollar, if only because this seems to be one of the publically stated objectives of the program. If this happens, immigrants from many countries will be in the situation that they can earn as much or more in their home countries than they can in the U.S.

So regardless of its effects on the rest of the US economy, QE2 may wind up solving the immigration problem. This will probably also help with unemployment.

QEII won't "fix the housing market"? The housing market will fix itself, if government will butt out and allow the normal market process to operate; prices will soon drop back to market-clearing levels. We don't need QEII to do anything about housing.

QEII won't "restore demand for wealth-elastic goods" (in a sustainable manner?). People's tastes change all the time; the economy adjusts. So what if people have lost their taste for a particular category of goods?

QEII "may not fix the general disconnect between expectations and reality"? What are you talking about? Do you not believe in the Efficient Market Hypothesis? Of course, the market's expectations are an imperfect guide to future reality, but I'll take them over Tyler Cowen's (or anyone else's) private expectations.

You "take seriously" the speculation that "QEII may set off bubbles in some emerging markets," but I'll bet you don't take it seriously enough to short any of those markets. That's not taking it *very* seriously!

QEII won't cure the common cold, either.


In an ideal world in which there was no difference between theory and practice, the Efficient Market Hypothesis would be true and useful. But in practice in the real world, it is not.

As a result there are opportunities for you to win money by finding inefficiencies in markets and exploiting them.

However, there are also opportunities for people who know a little more than you or who can control a little bit, either one, to exploit you.

Ya buys yer ticket and ya takes yer chances.

You can think of QEII as a dominant strategy in negotiating with other exporting countries who are happy to have their currencies undervalued.

To continue to undervalue their currencies, they have to continue to purchase dollars and keep them in their reserves. But, if the dollar will be worth less in the future, acquiring more dollars now to support their currency is a very expensive proposition.

Only the countries with trade surpluses have alarmed about QEII. Wonder why?

"The Fed simply needs to unload its heavy balance sheet without delay."

Spoken like a man with no experience in capital markets. I highly respect you, but man, that is a whopper. Unfortunately, when the Fed needs to unloads its heavy balance sheet, more likely than not, so will everyone else, creating a Lollapalooza effect that will be impossible to manage, that's the way bond runs happen.

Is there precedent for any entity unloading a balance sheet this size successfully (inflation adjusted or not)? Is there any precedent for any entity unloading a balance sheet 1/10th this size successfully (inflation adjusted or not)?

I agree that short term it's not going to lead to anything drastic (other than a few asset bubbles). But it's spectacular hubris to think that this size of operation can be managed without complication. They're playing an expensive game, and the cost of being wrong is enormous.

In an ideal world where there was no difference between theory and practice, the efficient market hypothesis is true and useful. But in practice in the real world, it is not. Therefore, there are opportunities for you to earn money by identifying inefficiencies in markets and exploit them.


Sorry, there is no evidence of CPI manipulation. Have you been listening to too much talk radio?

Also, blaming past commodity price increases on QEII is ridiculous. It just started. Those are already there. For whatever reason, mostly high unemployment, those price increases are not passing through. Raw material inputs simply are not that big a part of costs anymore, even oil.

"Couldn't it just be TIPS spreads are low because people have little faith in an honest CPI calculation"

I've wondered myself if people didn't trust TIPS to be the best inflation hedge, however if you expected inflation to be >10% you should be buying the shit out of TIPS and selling TBONDS because the spread is so narrow now. That's a free lunch compared to commodities, which may have already made their move.

'Doug, Sorry, there is no evidence of CPI manipulation.'

Define 'manipulation'. The methods used to calculate CPI have changed over time, and generally in such a way as to make the number lower than what the previous method would have given. See for one take on the matter.

I wonder how badly this is going to end...

As for the margins issue, just take a look at Csmpbell
Soup or Walmart.
As for the 'externalities'and understanding of the global backlash against QE2 I would like to bring to
your attention the text of a recent conference by Prof.Michael Hudson
'U.S. “Quantitative Easing” is Fracturing the Global Economy


"As Gary Becker has observed, banks have a trillion dollars beyond their capital requirements that they are not lending. QEII will just give them more."

@Tom Grey
"QE II, by raising most commodity prices, but not wages ... solves the wage stickiness downward problem.
Real wages go down."

@Bruce Krasting
"It will mark the end of a 30 year bull market in bonds. It will not support stocks in the long run. It will not solve the housing problem but it will cause inflation for everything that we consume. Everyone will be poorer as a result of QE."

I think the bases are covered. Either it won't do anything, or it will save the economy by reducing wages until we can compete with China on an equal footing, or horror of horrors it will end the bull market in bonds, and also hurt stocks!

Who's up to bat? Can he hit a home run that will let them all score?

Tyler, Does the post imply that the ugly guy in the picture has the least incoherent take on wage stickiness?

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