Chairman Ben Bernanke has announced that the Federal Reserve will buy about $600 billion of government bonds as part of what is being called QE2 (because this is the second big stage of “quantitative easing”).
This actually isn’t printing money, but it has the same effect in that it creates more liquidity by putting more money into the financial system. The theory is that all this extra money will drive down interest rates, and that lower interest rates will encourage people to take on more debt to finance additional spending.
There are several reasons why this is a bad idea and one potential argument why it is a good idea.
* It is a bad idea because rising prices are the inevitable result when there is more money chasing the same amount of goods.
* It is a bad idea because it assumes that the economy is weak because of high low interest rates. That is nonsense. Interest rates already are very low. Trying to drive them lower in hopes of stimulating borrowing is like pushing on a string.
* It is a bad idea because you don’t solve bad fiscal and regulatory policy with bad monetary policy. The economy is weak in considerable part because of too much spending, new health care interventions, and the threat of higher taxes. You don’t solve those problems by printing money, just like you don’t make rotting fish taste good with ketchup.
* It is a bad idea because the easy-money policy of artificially low interest rates helped create the housing bubble and financial crisis, and “hair of the dog” is not the right approach.
* It is a bad idea because no nation becomes economically strong with a weak currency.
* It is a bad idea because it may lead to “competitive devaluation,” as other nations copy the Fed’s misguided policy in hopes of keeping their exports affordable.
So what about arguments in favor of the Fed’s policy? There’s only one possible reason to support Bernanke’s policy, and at least one monetarist friend has offered this as justification for what is happening. I hope he’s right.
* The only legitimate argument for quantitative easing is if more money needs to be put in the system to counteract deflation. In other words, if the Fed focuses on its one appropriate responsibility – price stability, and if there is a legitimate concern of falling prices in the future, then an “easy-money” policy today could offset that future deflation.
By the way, some people say that the stock market’s recent performance is a sign that Bernanke’s policy is good for the economy. This is wrong because it confuses portfolio shifting with long-term economic performance. When the Fed creates liquidity, that drives down interest rates. What does that mean for investors? Well, it means that putting money into bonds will yield a lower return, so the only other major option is stocks. That is why Fed policy often leads (seemingly inexplicably) to short-term results that are at odds with the long-term consequences.
Here are some excerpts from a Bloomberg report.
Federal Reserve Chairman Ben S. Bernanke said the central bank must focus on the U.S. rather than overseas economies when trying to spur the recovery by purchasing an additional $600 billion in Treasuries. …Bernanke came under fire yesterday from officials in Germany, China, and Brazil, who said his plan to pump cash into the banking system may jar other economies and fail to fuel U.S. growth. Critics including Michael Burry, the former hedge-fund manager who predicted the housing market’s plunge, have said Fed policy is encouraging investors to take on too much risk and threatens to undermine the dollar. …“We are showing insufficient stimulus,” Bernanke said yesterday in his remarks, mostly in response to questions. Asset purchases have “the goal of reducing interest rates, providing more stimulus to the economy and, we hope, creating a faster recovery and an inflation rate consistent with long-run stability,” Bernanke said to students.
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The subsequent time I read a weblog, I hope that it doesnt disappoint me as much as this one. I mean, I know it was my option to learn, but I truly thought youd have something attention-grabbing to say. All I hear is a bunch of whining about something that you can fix in case you werent too busy looking for attention.
Eye Opening information on this website. A group of friends of mine were just talking about this. Cool
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Why would you want to counteract deflation? Isn’t that how the economy correct itself?
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Extremely interesting post.
Since it is totally obvious that “tight money” triggers crisis then their flawed logic tells them that ridiculously “loose” money solves crisis. In my Humble Opinion (IMHO) they are trying to cure hemorroids with cough syrup, as Mr. Mitchell says (of course he says it with very different words).
There was a huge loss of wealth when the housing bubble went “pop”. I think similar losses of wealth, like Japan in the 1990s, should be deeply researched before reaching conclusions. You will say that I am being “keynesian” but IMHO keynesians may be somewhat right here.
The FED has been buying housing related bonds as crazy, that is massive intervention in long term interest rates -lowering them- and in long term bond prices -rising them-.
Who is buying those bonds? Is the FED the main buyer or other people are too buying bonds at these prices?
One wonders what will happen to bonds if they start “tightenning” money and selling bonds as crazy. Will there be a HUGE bond collapse? It is extremely difficult to see such MASSIVE intervention in long term rates as a a good thing.
I have not looked at empirical data before saying this, so what I say here may be utter garbage because this lack of empirical verification but I think that the main force in increasing money may be people willing to take loans and so those billions are not as harmful as they seem at first glance.
IMHO opinion the SUPER EVENT was republicans controlling the house because that may mean lower tax rates, already markets signal the possibility that Bush Tax Cuts may be at least partially prolonged at least for a while. That would bring recovery. The anti keynesian message of the republican winners was utter clear, we knew they would win, but it was hard to know that the victory would be so sharp and the anti keynesian message so clear.
Dollar is going up now, since on the same day -wednesday 3- we had both super news -Republicans massive win and FED massive buying- one gets 2 SUPER IMPORTANT NEWS at the same moment.
It is obvious that tax cuts would help the stock market, that comes from the most elementary of finance, if the after tax yield of an asset increases then that asset price increases.
Maybe the FED timed the announcement of the massive buys with the republican victory so they can atrribute to their “easing” the good that the republican victory is doing.
It is very interesting that the dollar has been increasing since 4th november. One expects the FED easing to lower dollar, because there will be more money, and one expects the republican victory to raise dollar, since if there is more growth the FED will bring a higher dollar because it follows “inflation tagets”. There are other forces in action so one cannot conclude anything, but the rise of the dollar is interesting. There are, of course, other news that I do not know.
The main confusion in monetary policy is confusing the healthy rise in prices that prosperity brings with money losing value and confusing the fall in prices that a sick economy brings with appreciation of the currency; the great Supply Sider Robert Mundell has wroten a lot on this utter important fact, I will talk about that some other day because this comment is already too long
[…] I noted in an earlier post, monetary policy is not nearly as cut and dried as other issues, so I’m reluctant to make […]
Quantitative easing is just another letter to savers that says:
“We regret to inform you that your delayed reward for saving, i.e. postponing immediate gratification during a finite life, has just been reduced. We continue, however, to rely on savings to fund the unique American spirit of entrepreneurship and innovation, reduce the debt etc. Therefore, we hope that you will continue your, now ever more altruistic, participation in the public good as a saver.”
Sincerely,
The FED,
on behalf of a hurting public
The reduced reward comes in the form of lower returns and/or higher risk compared to what you anticipated when you were saving the money in the first place.
As they say, you can fool some people all the time and you can fool a lot of people some of the time. But there just aren’t enough people to fool enough times to have a prosperous life on the backs of those who forfeit immediate gratification in a finite life.
The bill of decline will come due sooner rather than later. Whether the bill is decline in the form of sustained low average growth or a series of intense crises separated by relative calm, or some combination of the two, remains to be seen. But one thing is certain: Higher prosperity founded on decreased incentives to produce is impossible.
“…If you can come up with “supply side” arguments that explain such a large decrease in productive capacity…”
I cannot quite come up with one single dominant argument now. However, by 2014 there will be at least one blatantly obvious reason. 2014 is the year where if I decide to make more than $88k per year then I will not only pay the 15-20k annual premiums for my own family’s health insurance but I will be forced to pay for someone else’s health insurance too, since my health insurance premiums will be paid with after tax dollars (…imagine, even worse, a high tax state such as California or New York). If on the other hand, I choose to drop my income below 88k then someone else (someone fool enough to still be striving to add more than $88k to GDP) will pay most of my 15-20k yearly insurance premiums. So what does everyone think I, and a lot of other people, will do?
I have rarely seen such a strong incentive to add less wealth to a country, produce less, work less, find an easier job, retire earlier, take more unpaid leave etc. than this. Such a progressive disincentive to produce is rarely seen, not even in Europe. Americans seem to have leapfrogged their European counterparts on their road to serfdom, on this one. Unfortunately, I think that this terrible incentive to produce may be addressed sooner or later by further coercive measures that attempt to force people to work more with little personal benefit. However, such measures will only throw more sand in the productivity engine. You can force people to show up at the office but you cannot force them to be creative, innovative, things that are essential to maintaining growth since they increase productivity by orders of magnitude.
Perhaps the current explanation for contraction in fundamental long term baseline productive capacity , is the generalized feeling that more redistribution is coming. So why bother that much about being ever more productive? Perhaps the increase in redistribution will be moderate under Republican governance or will be redistribution galore under the class warfare of Pelosi style Democrats. But in either case, there’s a generalized feeling that redistribution its coming. Hence the recession and recovery are happening under the backdrop of a populace that now has decreased long term personal incentives to produce. No amount of quantitative easing, analysis, or ever more complex economic jargon can change that. The vicious circle, what Dan calls the “Mitchell Rule” has started, and with the exception of brief intermissions seems rather unstoppable. Bad policy will trigger further bad policy. The economic decline brought by redistribution will trigger ever more class warfare which in turn will trigger more misery etc. There is little hope that the West can maintain its unique superior prosperity status in the world when 3 billion people have now gained enough economic freedom to be on their way to a non trivial fraction of Western per capita GDP, while, at the same time, the West seems to be backtracking towards redistribution and central planning.
Something exceptional, something that has almost never happened before, a sustained retreat from collectivism would have to occur for the US to escape this fate of decline.
I think your understanding is wrong. I would suggest reviewing Yeager. Selgin’s collection of essays from Yeager,
“The Fluttering Veil” covers the basic issues.
My view is that QE2 is justified because money expenditures on output should be higher.
Monetary policy can control money expenditures. Money expenditues are 13 percent below the growth path of the Great Moderation. For real expenditures to be the same as they were in Great Moderation, the growth path of prices and wages would need to be also 13 below the growth path of the Great Moderation. They aren’t even close. Prices are about 2 percent below the growth path path of the Great Moderation.
The problem is excessively low money expenditures, and the solutions are either a lower price level– deflation for a time– or else an increase in money expenditures.
Because deflation has not occured, real expenditures are about 11 percent lower the growth path of the great moderation. Firms will not produce what they cannot sell, and so real output and employment are on lower growth paths as well.
Of course, it could be that the productive capacity of the economy fell by that same amount. If you can come up with “supply side” arguments that explain such a large decrease in productive capacity, then the fall in money expenditures were fortuitous and do no harm.
Evidence that this must be true would be that the needed deflation has not already happened. Evidence that this is false is evidence that firms see their primary problem as inadequate sales, not a shortage of key productive resources.
What happens to nominal or real interest rates is really beside the point. And, as I explained, the process isn’t inflation or deflation and then changes in output. It is changes in money expenditures, and the changes in the price level dampen the changes in real output.
In my view, the ideal result of QE would be more money expenditures on output, no additional inflation, large increases in output and employment, higher real and nominal interest rates, and less debt. Of course, what actually happens depends on the response of market participants to the increase in money expenditures. My guess is that some inflation is an undesirable side effect.
What we do know is that if money expenditures return to the growth path of the Great Moderation, only modest inflation is possible in the long run. A 5 percent growth path of money expenditures is going to consistent with maybe 2 to 3 percent inflation int he long run.
You have invariably seen those cartoons with the boat where its own passengers are trying to propel it by blowing on their own sails. I would use that to illustrate to economics students the effect of most macroeconomic manipulations. Wrapped up in the technical jargon of modern economics, such manipulations attempt to convince that prosperity can be enhanced without fully liberating the overall fundamental long-term motivation to produce.
Such a boat is the current US economy. People are being rewarded for not rowing while those that row face an ever decreasing reward for their work. So, naturally, fewer and fewer people row and/or row less intensely. Meanwhile, macroeconomists have rounded up various groups of passengers to blow on the sails of the ship. While true appreciation of the analogy requires knowledge of elementary physics, most people comprehend the absurdity at some intuitive level. So someone please make a cartoon…
The overriding reality is that the greatest payback (fame/money) for macroeconomists is as manipulators. Most macroeconomic manipulations amount to essentially taking money from Peter, wasting some of it and then giving the remainder to Paul. Paul works less because he gets a subsidy and Peter retires earlier because it ain’t worth it. So while such moves are net losses, macroeconomists manage to bamboozle a desperate electorate into believing that such attempts at piecing together a macro-economic perpetual prosperity motion machine will enhance prosperity without most people working harder or, more importantly, engaging in higher value work or, not altering their productivity to take advantage of the government handouts that they are being offered.
By essentially luring/coercing savers into accepting returns that are out of line with the risks they are taking, this FED policy is yet another redistribution policy that forces savers to accept a lower reward for past work. This creates a precedent that lowers future long term incentives to save (i.e. forego immediate gratification to enable someone else to innovate, invent, produce – that is what saving and investment is).
So the policy amounts to an attempt to fool many people one more time. But for how long will the Fed be able to fool so many people so many times. Sooner rather than later the fundamnentals will override zero sum smoke and mirror manipulation attempts. It is simply as impossible to have a higher standard of living by producing less as it is to generate energy from nothing.
Keep hoping though American people. One of these days economists will finally engineer the perpetual machine of prosperity: Then the HOPE of prosperity through lower incentives to produce will finally become reality!