Some thoughts on QE

“Quantitative Easing” — economics jargon for central banks issuing a fixed quantity of base money to buy some stuff — has been much in the news this week. On Wednesday, US Federal Reserve completed a gradual “taper” of its program to exchange new base money for US government and agency debt. Two days later, the Bank of Japan unexpectedly expanded its QE program, to the dramatic approval of equity markets. I have long been of two minds regarding QE. On the one hand, I think most of the developed world has fallen into a “hard money” trap, in which we are prioritizing protection of existing nominal assets over measures that would boost real economic activity but would put the existing stock of assets at risk. My preferred policy instrument is “helicopter drops”, defined as cash transfers from the fisc or central bank to the general public, see e.g. David Beckworth, or me, or many many others. But, as a near-term political matter, helicopter drops have not been on the table. Support for easier money has meant support for QE, as that has been the only choice. So, with an uncomfortable shrug, I guess I’m supportive of QE. I don’t think the Fed ought to have quit now, when wage growth is anemic and inflation subdued and NGDP has not recovered the trend it was violently shaken from six years ago. But my support for QE is very much like the support I typically give US politicians. I pull the lever for the really-pretty-awful to stave off something-much-worse, and hate both myself and the political system for doing so.

Why is QE really pretty awful, by my lights, even as it is better than the available alternatives? First, there is a question of effectiveness. Ben Bernanke famously quipped, “The problem with QE is that it works in practice, but it doesn’t work in theory.” If it worked really well in practice, you might say “who cares?” But, unsurprisingly given its theoretical nonvigor, the uncertain channels it works by seem to be subtle and second order. Under current “liquidity trap” conditions, where the money and government debt swapped during QE offer similar term-adjusted returns, a very modest stimulus (in my view) has required the Q of E to be astonishingly large. The Fed’s balance sheet is now more than five times its size when the “Great Recession” began in late 2007, yet economic activity has remained subdued throughout. I suspect activity would have been even more subdued in the absence of QE, but the current experience is hardly a testament to the technique’s awesomeness.

I really dislike QE because I have theories about how it actually does work. I think the main channel through which QE has effects is via asset prices. To the degree that QE is taken as a signal of central banks “ease”, it communicates information about the course of future interest rates (especially when paired with “forward guidance”). Prolonging expectations of near-zero short rates reduces the discount rate and increases the value of longer duration assets. This “discount rate” effect is augmented by a portfolio balance effect, where private sector agents reluctant (perhaps by institutional mandate) to hold much cash bid up the prices of the assets they prefer to hold (often equities and riskier debt). Finally, there is a momentum effect. To the degree that QE succeeds at supporting and increasing asset prices, it creates a history that gets incorporated into future behavior. Hyperrationally, modern-portfolio-theory estimates of optimal asset-class weights come to reflect the good experience. Humanly, momentum assets quickly become conventional to hold, and managers who fail to bow to that lose prestige, clients, even careers. So QE is good for asset prices, particularly financial assets and houses, and rising asset prices can be stimulative of the economy via “wealth effects”. As assetholders get richer on paper, they spend more money, contributing to aggregate demand. As debtors become less underwater, they become less thrifty and prone to deleveraging. Financial asset prices are also the inverse of long-term interest rates, so high asset prices can contribute to demand by reducing “hurdle rates” for borrowing and investing. Lower long term interest rates also reduce interest costs to existing borrowers (who refinance) or people who would have borrowed anyway, enabling them spend on other things rather than make payments to people who mostly save their marginal dollar. Whether the channel is wealth effects, cheaper funds for new investment or consumption, or cost relief to existing debtors, QE only works if it makes asset prices rise, and it is only conducted while it makes those prices rise in real and not just nominal terms.

In the same way that you might put Andrew Jackson‘s face on a Federal Reserve Note, you might describe QE as the most “Kaleckian” form of monetary stimulus, after this passage:

Under a laissez-faire system the level of employment depends to a great extent on the so-called state of confidence. If this deteriorates, private investment declines, which results in a fall of output and employment (both directly and through the secondary effect of the fall in incomes upon consumption and investment). This gives the capitalists a powerful indirect control over government policy: everything which may shake the state of confidence must be carefully avoided because it would cause an economic crisis.

Replace “state of confidence” in the quote with its now ubiquitous proxy — asset prices — and you can see why a QE-only approach to demand stimulus embeds a troubling political economy. The only way to improve the circumstances of the un- or precariously employed is to first make the rich richer. The poor become human shields for the rich: if we let the price of stocks or houses drop, you are all out of a job. A high relative price of housing versus other goods, a high number of the S&P 500 stock index, carry no immutable connection to the welfare or employment of the poor. We have constructed that connection by constraining our choices. Deconstructing that connection would be profoundly threatening, to elites across political lines, quite possibly even to you dear reader.

A few weeks back there was a big kerfuffle over whether QE increases inequality. The right answers to that question are, it depends on your counterfactual, and it depends on your measure of inequality. Relative to a sensible policy of helicopter drops or even conventional (and conventionally corrupt) fiscal policy, QE has dramatically increased inequality for no benefit at all. Relative to a counterfactual of no QE and no alternative demand stimulus, QE probably decreased inequality towards the middle and bottom of the distribution but increased top inequality. But who cares, because in that counterfactual we’d all be in an acute depression and that’s not so nice either. QE survives in American politics the same way almost all other policies that help the weak survive. It mines a coincidence of interest between the poor (as refracted through their earnest but not remotely poor champions) and much wealthier and more powerful groups. Just like Walmart is willing to stump for food stamps, financial assetholders are prone to support QE.

There are alternatives to QE. On the fiscal-ish side, there are my preferred cash transfers, or a jobs guarantee, or old-fashioned government spending. (We really could use some better infrastructure, and more of the cool stuff WPA used to build.) On the monetary-ish side, we could choose to pursue a higher inflation target or an NGDP level path (either of which would, like QE, require supporting nominal asset prices but would also risk impairment of their purchasing power). That we don’t do any of these things is a conundrum, but it is not the sort of conundrum that staring at economic models will resolve.

I fear we may be caught in a kind of trap. QE may be addictive in a way that will be painful to shake but debilitating to keep. Much better potential economies may be characterized by higher interest rates and lower prices of housing and financial assets. But transitions from the current equilibrium to a better one would be politically difficult. Falling asset prices are not often welcomed by policymakers, and absent additional means of demand stimulus, would likely provoke a real-economy recession that would harm the poor and precariously employed. Austrian-ish claims that we must let a recession “run its course” will be countered, and should be countered, on grounds that a speculative theory of economic rebalancing cannot justify certain misery of indefinite duration for the most vulnerable among us. We will go right back to QE, secular stagnation, and all of that, to the relief of both homeowners, financial assetholders, and the most precariously employed, while the real economy continues to underperform. If you are Austrian-ish (as I sometimes have been, and would like to be again), if you think that central banks have ruined capital pricing with sugar, then, perhaps uncomfortably, you ought to advocate means of protecting the “least of these” that are not washed through capital asset prices or tangled with humiliating bureaucracy. Hayek’s advocacy of a

minimum income for everyone, or a sort of floor below which nobody need fall even when he is unable to provide for himself
may not have been just a squishy expression of human feeling or a philosophical claim about democratic legitimacy. It may have also have reflected a tactical intuition, that crony capitalism is a ransom won with a knife at the throat of vulnerable people. It is always for the delivery guy, and never for the banker, that the banks are bailed out. It is always for the working mother of three, and never for the equity-compensated CEO, that another round of QE is started.

FD: For the first time in years, I hold silver again. It hasn’t worked out for me so far, and was not based on any expectation of inflation, but since I write in favor of “easy money”, you should know and now you do.

Update History:

  • 2-Nov-2014, 6:55 p.m. PST: Added link to Ryan Cooper’s excellent Free Money For Everyone.
  • 2-Nov-2014, 8:50 p.m. PST: “The right answers to that question is are
  • “But who cares, because, in that counterfactual”.

53 Responses to “Some thoughts on QE”

  1. Meanwhile, down here in Australia, the Great Moderation goes on and on and this whole QE thing seems just weird. But our central bank has a target that implicitly supports total income/spending in the economy, since it’s target is an average of 2-3%pa inflation over the business cycle. What we might call “broad’ inflation targeting rather than narrow inflation targeting.

    In fact, it looks a lot like a sort of ersatz NGDPLT policy, or one of maintaining total spending in the economy, which Hayek was also in favour or.

  2. That would be “in favour of”.

  3. CMA writes:

    QE or other forms of asset purchases complicate monetary policy because the central bank ends up expanding liquidity to investment oriented entities with unstable money demand. This is especially true at the ZLB where speculative demand for money can become extremely elevated. The general public on the other hand have a much lower speculative demand for money. Especially all the unemployed, people on low incomes and with low or negative net worth.


    How does the RBA implicitly target income? I cant see it.

  4. Peter K. writes:

    What you’re saying about QE could be said about monetary policy in general and the two need a better defense than this, although I generally agree. It could be that in Germany and Northern Europe with their more general social insurance program they size up monetary policy this way as well, like a Hayekian, which is why they raised rates prematurely in 2011 and are only now resorting to QE as they teeter on the precipice. We may see that counterfactual case in Europe.

    I think the following sentence suffers from “ceteris paribus” as many things do in macro: “I suspect activity would have been even more subdued in the absence of QE, but the current experience is hardly a testament to the technique’s awesomeness.”

    Like Obama’s stimulus, what was QE working against? 1) Fiscal austerity, as the deficit was reduced from 10 percent to 2.8 percent. QE3 might have been insurance against sequestration and the debt ceiling clown show. As soon as that had passed they tapered ASAP. It does look like the Fed isn’t comfortable with QE either as it expands their balance sheet; is sort of a fiscal policy; demonstrates they can influence long term interest rates and effect the deficit (very anti-Kaleckian, see JW Mason); etc. It pulls back the curtain a bit opening the way to helicopter drops, the trillion dollar coin, etc. It’s why they tapered too soon, but as long as the economy survives it’s okay with them. No hurry to close the output gap and hit their inflation ceiling.

    2) QE was also working against a $500 billion/year trade deficit hole in demand. It does seem like it’s mostly about a vague forward guidance (see Mike Konczal’s latest on how they did QE backwards). Whenever inflation expectations dipped they did a QE (1,2,3) and expectations went back up. But it wasn’t very cost effective, but better than nothing, again. An NGDP path level target would be much “cheaper,” but again it would foist explicit responsibility for the economy (and the budget!) on the Fed. Currently they have sort of a vague deniability. “They’re trying to hit their inflation target, but it’s so hard.” No it’s not hard. They’re politically compromised. They make up excuses about financial instability. They don’t put up a strong defense of QE because that would really lay out how responsible they are for the economy.

    Journalists and members of Congress could be asking the Fed at every one of their press conferences and hearings, about why since QE works, the Fed didn’t do enough to get the economy back to normal in a reasonable time frame? They should be pressed on this. They should but they don’t because Congress doesn’t care, the corporate media doesn’t care and even Obama didn’t make it a priority to nominate governors to the FOMC. The powers that be would rather have subpar growth and loose labor markets. Doing enough QE is not a priority, so the concept of QE, like monetary policy, like Obama’s stimulus, suffers. If they had done much more QE and allowed inflation to exceed their ceiling target, the slant on QE in posts like this one would be a little less negative I bet. Instead incomes have stagnated during Obama’s Presidency, his approval numbers are low and the Democrats hand the Senate over to the Republicans who won’d do much more equality.

    Let’s see what happens with Japan where they couple QE with a lower unemployment rate and higher employment to population ratio. Can they hit their 2 percent inflation target? If so, the U.S. could hit 3 or 4 percent if the Fed so desired.

  5. Peter K. writes:

    I forget to mention Larry Summers point (made earlier by other economist like Beckworth, Farmer and Hamilton etc.) about how Treasury and Geithner negated up to third of QE’s effects via tightening via duration changes. Did the Fed compensate or not? My guess is not.

  6. stone writes:

    I’m wondering whether a key initial effect of QE was to cause currency exchange rate shifts in a way that was bound to reverse.

    QE left institutional investors holding cash that they were then looking for something to do with. They ended up financing corporate USD denominated debt in places such as Turkey. As that stock of debt expanded, it weakened the USD (because lent USD were being exchanged into local currency to pay for building skyscrapers in Turkey and such like) and so caused USD denominated commodity prices to rise (hailed as QE “working”). But now that stock of debt has expanded as much as it can and needs servicing. Servicing that debt is causing a great demand for USD and so strengthening the USD and suppressing commodity prices.

    I wonder whether QE has ended up spreading debt deflation across the world.

  7. Dan Kervick writes:

    “… economics jargon for central banks issuing a fixed quantity of base money to buy some stuff.”

    Of course the stuff they buy is just more money, or rather promises for the payment of money on a specified schedule. So what flows out of the central bank via quantitative easing flows right back in, with interest, as these promises come due. In the meantime there is a temporary boost in demand for promises and the price of promises. This can make some rich people and institutions feel richer for a while. Any other effects of QE, positive or negative, are due to psychological voodoo.

    That isn’t to say that the psychological voodoo doesn’t have it’s own sort of reality. Like medical placebos, fancy authoritative statements about what the central bank “expects” or has “targeted” can have a self-fulfilling impact to the extent that people believe those statements, or have at least mutually agree to jointly pretend they believe them. But I think now most of the mystique and confusion about these operations has been dispelled, so the Wizard of Fed’s purple smoke machine has probably lost its power to awe and motivate.

  8. CMA. The RBA’s monetary policy target is (from their website

    The Governor and the Treasurer have agreed that the appropriate target for monetary policy in Australia is to achieve an inflation rate of 2–3 per cent, on average, over the cycle. This is a rate of inflation sufficiently low that it does not materially distort economic decisions in the community. Seeking to achieve this rate, on average, provides discipline for monetary policy decision-making, and serves as an anchor for private-sector inflation expectations.

    Which means that (using M=kPy or, if you prefer, MV=Py) if y starts falling, they tolerate a bit more of a rise in P (i.e. they loosen monetary policy), and if P starts rising too much (typically due to a surge in y), they tighten monetary policy. So, more y, less P; less y, more P. Which means that Py (aka NGDP) can be expected to have a relatively stable path. Which it does. See here.

  9. A writes:

    This asset price to wealth effect theory of QE seems susceptible to the Fisher Effect. Asset buyers may increase their nominal bids due to low interest rate expectations, but those are the result of Fed lowered inflation expectations for a given real return. In this scenario of absolute monetary credibility, asset price increases must have overcome the lowered nominal return pathways of those assets. If there is a subsequent wealth effect, it would have to appear in a nation where the central bank has staked its credibility on maintaining an interest rate path, by hook and by crook.

  10. Detroit Dan writes:

    The mistake here is in thinking that QE has any lasting effect on stock and housing prices. Having the central bank buy government bonds is one thing, since these are government guaranteed from the start. The fact is that QE (Treasury bond buying) does not in any way guarantee stock prices. We are likely to have the equivalent of 1929 with the public placing their life savings in accounts (e.g. 401k savings accounts) that are not guaranteed by the government. Stock prices have fallen by more than 50% in the U.S. twice in the last 14 years. Before long we will have to deal with the fact that stock prices are not government guaranteed, and that life savings can be decimated over a matter of months.

    Would you be willing to have QE based upon government buying of stocks? If yes, pure capitalists lose, as the return to capital becomes further separated from actual profitability. The nominal winners, stockholders, would in effect become further enthralled to big government. So perhaps what SRW is endorsing is kind of a reverse psychology.

    More likely is that there will be dominant recognition that government should deal more directly with problems caused by macroeconomic failure. The alternative to QE expanding into purchases of stocks (of for-profit enterprises) by the central bank is that fiscal policy will move into New Deal territory, as it should.

    Either way, it should be noted that QE is nonsense — an absurd technical sounding term to cover up whatever is really happening. What SRW is really reluctantly endorsing here is the expectations fairy — the idea that we should do nothing and pretend that we are doing something significant, with the hope that are expectations will be correspondingly bolstered. Nothing could be more certain to fail…

  11. Brett writes:

    It seems to me that the biggest advantage is that the Central Bank can do it, and do it quicker than a legislature can pass fiscal stimulus in the present political climate. Like anything political that could change in the future, but for now doing cash transfers would rely on either “automatic” programs or expanding the legal policy actions of the Federal Reserve to distribute money directly via cash transfers.

  12. […] Some Thoughts on QE […]

  13. Peter K. writes:

    @ 7

    Spoken like a true German or Austrian, put in the most insulting way possible. The feeling is mutual.

    Dean Baker disagrees:

    Paul Krugman disagrees:

  14. Steve,

    I suspect that QE “succeeded” to the extent that it induced a shift in private portfolio preferences (i.e toward greater risk assets), and to the extent that those asset prices rose, it might have had some impact of the propensity to spend on the part of the beneficiaries. So to that extent, it did have a quasi-fiscal impact, although as you acknowledge, if that was the intent, there were much better ways to achieve the result. To the extent that we had those “horrible” fiscal deficits that so exorcised the Tea Party (and even Obama to some degree) I think this had a much more significant impact, as demonstrated by the relative strength of the US economy vis a vis the Eurozone. Okay, but the champions of QE might well argue that the outlook in the Eurozone is poorer because, unlike the Fed, the ECB never undertook QE.

    There’s a few things to be said here. For one thing, although the ECB did not undertake a program exactly like the Fed, it did undertake some bond buying (largely in the secondary market) which had the effect of mitigating the existential risks posed to the euro by virtue of the fact that the sole currency issuing entity in the Eurozone was finally backstopping the bonds of the periphery nation, thereby giving credibility to the pledge subsequently undertaken by Mario Draghi to do “whatever it takes” to save the Eurozone.

    But as we’ve noted on many occasions, the ECB’s actions did nothing to address the problem of aggregate demand, which remained deficient by virtue of the ongoing austerity programs undertaken in the Eurozone.

    One can argue that the fiscal deficit came down too rapidly in the US, which is why income growth remains sluggish, but it certainly put a floor on demand at the worst stage of the crisis in 2009 and helped to restore employment growth as a consequence (ironically, if the ‘socialist’ President Barack Obama kept public sector employment flat, as most of his predecessors had done, rather than shrinking it, the US employment picture would be even better).

    As for QE itself, in truth, the Fed has done only two helpful things. First, during the liquidity crisis of 2007 and 2008, it lent reserves to financial institutions that faced a liquidity crisis. To be sure, it took the Fed far too long to figure out that in a liquidity crisis you must lend to any financial institution, and you should not look too closely at the quality of assets submitted as collateral. The Fed’s bumbling made the liquidity crisis far worse than it should have been. But eventually we got through that phase.

    We then moved on to the insolvency phase, as everyone discovered that banks were, and still are, holding assets whose value is far below the value of their liabilities. A flimsy “stress test” was concocted, designed to ensure that all institutions would pass. The government then injected a bit of capital into some of them and proclaimed the problem resolved. Next, banks cooked their books and showed healthy profits so that they could buy out Uncle Sam. More importantly, they wanted to party like it was 1999 so they could pay record bonuses to top management.

    However, purchasing toxic assets from banks did help them — the second useful thing done by the Fed. The problem is that the Fed did not and cannot buy enough of the waste to make banks healthy. There is simply too much of it. When the crisis hit, the US debt to GDP ratio was 500%, and is still multiples of GDP.

    The Fed can certainly “afford” to buy up all the bad assets and take on any counterparty risk from the derivatives that might be triggered. As Bernanke and Yellen have both affirmed, the Fed buys assets by crediting bank accounts, through a simple keystroke, and there is no way the Fed can run out of keystrokes.

    But it is politically constrained in a number of ways.

    First, there is no chance that inflation hawks would stomach Fed actions on that scale. They still believe that bank reserves generate loans that inevitably create inflation. When he was Fed Chairman Bernanke carefully tried to navigate these waters by agreeing with the hawks that in the long run, Fed creation of too many reserves would be inflationary, but argued that in current circumstances the greater danger is deflation. Still, he reassured markets that reserves creation is temporary, and that the Fed would “exit its accommodative policies at the appropriate time”. Yellen is now making good on that pledge.

    Second, the Fed generally makes a profit on its operations and turns excess profit on equity over to the Treasury. Buying toxic assets on the scale that would have been required to fully clean up the TBTF banks would have led to losses, albeit only significant from an accounting perspective. Still, this is something Congress could not stomach and probably would have put the Fed under even great political constraints. Indeed, its very existence might have come under even greater Congressional threat, if it were have been seen as giving such a huge and unjustified windfall to a bunch of banks which had acted with brazen criminality.

    So the Fed was left with the only option available to a central bank that has already pushed short-term interest rates to zero: buy longer maturity treasury bonds in order to push longer rates toward zero and thereby provide a huge subsidy to borrowers (and hopefully kickstart the housing market on the grounds that historically low rates would attract bottom fishers into the market. But borrowing best occurs when there is job creation and rising wages. We have a bunch of “McJobs” and not much in the way of rising wages. Hard to give the Fed credit for doing much there. A low interest rate policy will not spur borrowing until economic recovery is underway, but recovery will not begin until spending picks up. Only jobs and income will stimulate spending, but the Fed cannot do anything in those areas. That’s again the role of fiscal policy.

    The Fed believes that it might spur bank lending by lowering returns on safe, liquid assets like Treasuries. If banks cannot generate sufficient returns by holding these assets, then they might have no choice but to take greater risks. But it takes two to tango — banks need good and willing borrowers in order to make loans.

    Recent data indicate that banks are instead trying to increase revenues through “churning” — trading existing assets, which generates no new spending — and by increasing fees and penalties. Conventional wisdom is that it costs banks up to 400 basis points (four percentage points) to operate the payments system that relies on checking deposits and credit cards. If Treasuries are paying less than half that, and mortgages are below that, the only way that banks can turn a profit is by charging customers for their deposits, debits, and charges. That is why they have been busy jacking up their charges and remaining awful for most ordinary Americans to deal with. Again, not much of a win for QE.

    No matter how mad at banks we might be, we have got to leave them with a way to return to profitability that does not rely on speculative bubbles, pump-and-dump schemes, and accounting fraud. Pushing returns on relatively safe assets toward zero is not the answer. Pumping banks full of reserves that pay very low interest will not help, either. What Yellen understands, but most in the mainstream media do not, is that banks do not and cannot lend reserves. Reserves are just an entry on the Fed’s balance sheet — a liability of the Fed and an asset of banks. Rather, banks make loans by accepting the IOU of the borrower and issuing a demand deposit. Only financial institutions have access to the Fed’s balance sheet, so it is literally impossible for a bank to lend out reserves.

    So anyone who thinks that pumping banks full of reserves while driving interest rates toward zero was a way to encourage lending simply does not understand banking. And it also means that the Fed was being disingenuous by claiming that it played such an important role in helping to reduce unemployment, when it was surely those much reviled fiscal deficits that really deserve the credit.

    Note that if we really wanted to use our central bank to resolve this economic crisis, it would be far better to have it create jobs for the unemployed. But that’s beyond its remit. It makes far more sense to use our fiscal authorities for that.

    QE in short did not do what its promoters claimed. Fiscal policy saved the day to the extent that anything has improved, and it is positively misleading for Ms Yellen (or anybody else on the Federal Reserve) to claim otherwise. The good news? Stopping the program is hardly likely to have the dire impact on the economy that the doomsayers now suggest. Just as QE itself was a damp squib, so too is its cessation.

  15. Jason Smith writes:

    This is outside the mainstream of macro, but here’s a model that says only about $200 billion of QE 1 actually did anything directly:

    Additionally, it makes the case for helicopter drops to steer the economy — anything that would cause more currency to enter circulation. That also includes reducing lowering long term interest rates.

  16. Dan Kervick writes:

    @Peter K. “Spoken like a true German or Austrian, put in the most insulting way possible. The feeling is mutual.”

    I didn’t insult anybody. I was direct, but not insulting and I used no names and attacked no individuals – unlike you. On the other hand, I don’t feel the need to stroke egos or grovel before the usual gurus.

    Also, having encountered Austrians many times over the past four years in discussions about QE, I can assure you they do not share my views. They are convinced that QE amounts to the central bank “running the printing presses”, and that QE therefore threatens inflation, hyperinflation, uberinflation, catastrophe. Sometimes they go on further about “ending the Fed”, gold prices, Rothschilds, etc. As you know, my view is that QE is of little actual significance, and most of whatever effects it has are due to the hype and ballyhoo that surrounds it.

    I think Yellen is doing a perfectly fine job managing the neurotic markets and the hyperventilating economic pundits who hang on every lunch order she places like it was a fortune cookie from the economic gods; and I feel grateful every day that the greedy, prima donna charlatan Larry Summers is not there hogging limelight, mesmerizing the CNBC crazies and turning his empty pontificating into actual policy.

  17. Dan Kervick writes:

    SRW: “I fear we may be caught in a kind of trap. QE may be addictive in a way that will be painful to shake but debilitating to keep.”

    Right, that is the worry that emerged during the obsessions last year about whether the Fed was or was not going to “taper”. First we got several months of economic perversity where the markets wrapped themselves up in knots and treated every piece of good news as a piece of bad news (because if the economy was getting better, then the Fed might do that terrifying tapering), and treated every piece of bad news as a piece of good news (because if the economy is getting worse, then the Fed will back off on the tapering and yippee!).

    The QE hype created a whole manaic culture of market watchers and participants who became convinced that QE was “keeping the economy afloat” and who thus became addicted to a steady stream of reassuring news about the Fed’s determination to keep doing whatever it is they were doing, because you know, all the wise guys think whatever it is is really, really, really, really important.

    Peter will think I’m being mean again, but this is the kind of craziness you get when you go down the road of hall-of-mirrors economic policy based on expectations of expectations of expectations; on games for generating 2nd, 3rd and 4th order effects; on “nudges”, misdirection, noble lies, tactical falsehood, pompously announced but operationally mysterious “targets” and a whole subculture and decadent intellectual industry devoted to divination and soothsaying in response to the cryptic sayings of the Master. It becomes impossible to do any clear thinking and direct first-order policy. I think this is the late, collapsing stage of hyper-reflexive postmodern economic thinking, where there is no longer a real material world of real, first-order economic value, but only a neurotic casino world of money, promises and rates, and everybody is trying to out-think everybody else about the social construction of the social construction of the social construction of value. This kind of thing appeals to a certain kind of mind, but I suspect we’re going to get a new generation of more concrete and classical economic thinkers who have their feet on the ground, the attention focused on the real world, and are not lost in money-space.

  18. stone writes:

    SRW, you say the “Austrian-ish” approach of letting recession “run its course”, would be slow and grim. I agree that that became true once the financial system was rescued in the aftermath of the 2008 crisis. BUT I really wonder whether the best possible counterfactual alternative path would have been to have just let the whole sucker go down in 2008 and then to have started afresh -freed from the bloated financial sector. Think how thoroughly and quickly Germany bounced back after the currency reforms of 1948 straight into the Wirtschaftswunder.

    If the 2008 crisis was caused by a strangling web of disfunctional claims over our productive capacity then perhaps all that was needed was to let that web slip away and then the economy could prosper once again. Government intervention could instead have been directed towards the real economy -ensuring that all pensioners got a decent living and all valid insurance claims were met and such like -rather than on “saving the world” with bailouts of the financial system.

    I’m not sure that this is just idle reflection on past history either. Presumably we are going to get another 2008 style flop at some point. I think we need to ensure that we don’t all get bamboozled into “doing what it takes” to save ever more dysfunctional and counterproductive financial institutions.

  19. […] Some thoughts on QE Steve Waldman (Scott) […]

  20. reason writes:

    Peter K.
    @6 You mention JW Mason – did you mean to link? (I like the stuff he writes but as far as know it is not well known).

    @18 – Don’t think Post WWII Germany is a good example – they had external help, and times were very, very hard. (I think a whole generation still shows signs of being traumatised by the experience – I live in Germany and people of that generation are infamous for their long faces and determination to get to the front of any queue).

  21. stone writes:

    Reason@20, I’m really interested by the post WWII German experience. The financial reforms used in post WWII Germany weren’t a cause of the real suffering were they? They seemed to me to rather be part of the solution that worked out so well. Obviously the overall real (rather than financial) situation was a nightmare -14000000 people had to up root and leave territory that became part of Poland etc and those displaced people had to be assimilated and also everything was bombed flat. But after the 1948 currency reforms the country was rebuilt astonishingly quickly. I also think a lot of it was built by Germans. The USA did a great job of setting things on the right track in the first instance but Germany was not a major drain on resources from the USA. -please correct me if I’m wrong.

    By contrast the 2008 financial crisis left no one directly with physical injuries (but the 2009 speculative grain price spike did starve millions in developing countries), there was no bomb damadge, there were not millions of people ordered to abandon their homes due to borders being redrawn. The real causes of real suffering (such as in post WWII Germany) were not there. I’m only making the comparison with post WWII Germany as a way to show that a dramatic clean sheet redrawing of the financial system can work wonders even against a great headwind such as the real destruction that post WWII Germany had to rebuild from.

  22. reason writes:

    stone @21
    Reading that wikipedia link, it sounds like the reforms were straight redistribution more than monetary reform.

  23. stone writes:

    reason @22, whatever we choose to call it, it seemed to work and perhaps is what is now needed once again?

  24. […] Interfluidity […]

  25. reason writes:

    stone @23
    What does giving everybody some new money, exchanging existing balances to new money at a discounted exchange rate and continuing to pay wages, pensions etc at a higher exchange rate sound like to you, if not taking from those with more and giving to those with less. i.e Redistribution.

  26. stone writes:

    reason@25, I agree with you that that was what it amounted to -sorry if I wasn’t being clear.

  27. Thorstein writes:

    James Grant, contra RSW, argues in The Forgotten Depression: 1921: The Crash That Cured Itself (2014):

    “Between January 1920 and August 1921, the unemployment rate in the United States jumped to 14% or so from about 2% …, wholesale prices plunged by more than 40%; and industrial production fell by 23%. The farm economy reeled, and there were waves of business failures….

    {Elsewhere, Grant has written industrial production dropped by 31.6%, stocks by 46.6% and wholesale prices by 40.8%. “The collapse in wholesale prices was reckoned the most violent in American annals up until that time.”}

    “The administration of Warren G. Harding responded to this macroeconomic disaster by running a budgetary surplus. The Fed didn’t lower interest rates but raised them. In response to this bitter medicine, or perhaps despite it, the economy staged [a] bounce-back…. In 1922, the first full year of recovery, industrial production leapt by 27.3%. By 1923, joblessness was back to 3%.

    “from the peak to the trough of the 1920-21 business cycle, the sum of checking accounts and currency fell by 10.9%.

    “QE was not even a gleam in the central bank’s eye [in 1920–1921]—how did the American economy right itself? How did the banking system survive?

    “[The1920–20 Depression] was ugly and sharp, but it ended 18 months after it began. And in the course of it ending, the Treasury reduced the public debt to $22.9 billion from $24.3 billion. According to 21st-century doctrine, producers and consumers are incapable of climbing out of a deflationary hole without a government-provided fiscal and monetary ladder. Nonetheless, in this particular unsung depression, individuals managed the trick, which suggests that markets work if only we let them.

  28. […] Quoted at length from Steve Waldman, (Interfluidity): […]

  29. reason writes:

    this depression was post ww1. One thing that wars do is, stop people spending and force them to save. The depression could right itself because people had money and weren’t up to their necks in debt. The policy was irrelevant.

  30. reason writes:

    note also that interest rates were raised before the recession and fell during the recession (i.e. no liquidity trap).

  31. reason writes:

    In fact the 1920-21 recession/short depression amounted to an extremely botched demobilisation. Yes, the recovery was due to a combination of monetary policy and the real balance effect, but the rapid recovery was in many ways a reflection of the atypical cause of the problem than something you could use to draw general conclusions.

  32. […] Quoted at length from Steve Waldman, (Interfluidity): […]

  33. Seth writes:

    So QE is a helicopter drop — but only for those with helipads.

    Just realized GW Bush did a pint-sized helicopter drop with his tax rebate checks (printed to say they were from “Austin, TX” ‘natch) back in ’02 or so. Maybe we’re selling the helo-drop concept the wrong way? Could Obama and McConnell agree on a big round of “middle class tax cuts” (one time checks) as a form of stimulus that Team-Red-USA!!(TM) could accept?

    I shudder to think what sort of corporate give-backs would be required to compensate (in the spirit of your Kalecky quote) for such kindness to nobodies. And it is also politically hard to use the US income tax code to target such “rebates” to the Romney 47% “lucky-duckies” who are too poor to owe the IRS anything to begin with. But still better than endless trickle-down via QE, perhaps.

  34. ChrisA writes:

    Late to the party, but Steve you are over thinking this. QE is simply money printing, which is inflationary ceteris paribus, with inflation meaning, in this case, more money for each given asset. The act of printing of this money lowered Government nominal debt (ignore the fiction over the Fed’s balance sheet, the Fed is part of the Government) – there can be no debate on this, the Government has more nominal money after the printing than before. Reductions in Government debt are, by the Lucas critique (and common sense), equal to future tax cuts, so are equivalent to helicopter drops. What assets the printed money is spent on is irrelevant to this argument.

    An even simpler way of looking at QE; either it is inflationary, which gives us the needed stimulus through lower real interest rates, or it is not, in which case it is the best free lunch ever, since we can reduce government debt with no cost. It can only be one of these two possibilities and both are good.

    Now as to the empirical evidence, you seem to be complaining that QE has not stimulated enough, well the answer seems clear, since inflation is still below target, do more QE until we reach the target!

  35. reason writes:

    No the answer is to increase the velocity of the helicopter drops, by giving them to the right people. Whether we call that monetary policy or fiscal is a matter of indifference to me.

  36. reason writes:

    stone @26
    Seriously, I like to call a spade a spade (can you say that on an American blog – is there a politically correct equivalent)? Obfuscation annoys me.

  37. ChrisA writes:

    @Reason – “No the answer is to increase the velocity of the helicopter drops, by giving them to the right people.”. What question is your “answer” a response to?

    Perhaps you mean that we would see more inflation for less money printing by giving money directly to people rather than using it to reduce government debt by buying treasuries? Well perhaps, I don’t know, and I suspect you don’t either. People could just save the money, since it would be seen as a temporary windfall, rather than spending it. But let’s say you are correct. Why would you want to increase the power of the money printing/inflation ratio? If buying debt is less inflationary than direct payments, then that method allows you to do more money printing and take the free lunch of reducing government debt even more without stoking inflation.

  38. stone writes:

    ChrisA@38, once interest rates are at the zero lower bound, I don’t understand why you consider it so transformative to exchange bank reserves for say short term treasury bills. Once there is ample amounts of “money”, much of it will be held merely as a store of value (rather than as a medium of exchange) and for that purpose, short term treasury bills do the job just as well don’t they?
    I had also a go trying to grapple with that in:

  39. stone writes:

    ChrisA@38, when you say that exchanging bank reserves for treasury bills “reduces government debt”, I guess that viewpoint depends on the idea that funding the government with a stock of treasury bills is somehow something that will need to be reversed whilst funding with a stock of bank reserves won’t. I don’t see any reason to imagine that there is any such difference.

  40. ChrisA writes:

    Stone – again you are making things complicated that are actually pretty simple. The Government prints more money. It then has more money (in nominal terms) than it did before. This is a truism. There cannot be a debate about this. It then uses that money to buys things. If it buys its own debt, then it definitely has reduced outstanding debt. Again a truism. There is less (nominal) debt now than before. How can that not be true?

    The argument you advance on that inflation won’t result from this cancelling of Government debt, because the market might anticipate that the debt might be sold again does not actually change the fact that the net debt of the Government has actually been reduced. Maybe inflation would happen or maybe not. If inflation does happen, great, we have done our job. If inflation doesn’t happen, even better, now we have costlessly retired some Government debt. Let’s do more!

  41. stone writes:

    ChrisA@41, what I’m trying to say is that the bank reserves are debt securities in much the same way that the short term treasury bills are. The government hasn’t retired its overall debt by exchanging bank reserves for short term treasury bills; it has merely altered the term structure of that debt in a perhaps insignificant way (from treasury bills to instant/perpetual bank reserves). The government may not even have reduced its interest payments since sometimes higher interest is paid on reserves than is paid on treasury bills.

    I do wonder whether the more recent style of QE -buying longer term debt securities- can make it very awkward for the central bank to subsequently hike interest rates by a large amount. To that extent QE may act to reassure people that we are going to have very low interest rates for a long time. BUT since essentially everyone tells me I’m wrong about that, perhaps QE doesn’t even do that.

  42. ChrisA writes:

    Stone – simply put, the Government doesn’t have to pay interest on reserves. Indeed it can pay negative interest rates if it chooses. Bonds however have a fixed interest payment that must be paid. Banks reserves are therefore not the same as treasuries. Also, the amount of reserves that the Government accepts from the banks can also be limited.

    We can do a thought experiment on this. Let’s say the Government buys all the treasury debt that exists. This creates a large cash balance for the banks (note that they are not the only ones holding the debt, foreign governments and individuals also hold the debt but lets just assume). Then they place that cash in reserves. And the prevailing interest rate on reserves is the same as the interest rate previously given on treasuries. The next day, the Fed announces the interest rate on reserves will now be zero, which they can do at their whim. Regardless of whether the banks then withdraw their cash from reserves (stoking inflation) or they keep it in reserve (thus being non-simulative) we, the tax payer are better off. Now we have no interest to pay on any debt. Paying back the reserves is also no problem, don’t tax it or borrow it, print it, after all we have already accepted that this is ok to buy the debt back in the first place using printed money, so why would we need to sell securities to get the money?

  43. stone writes:

    ChrisA@43, you’re saying that it would be better if interest rates were set at zero and longer term, coupon yielding debt was bought back. Fair enough.

    I’m just saying that QE seems to be being done in a way that suggests that there is a belief that it does something over and above pegging interest rates. In the 1940s, the central banks did what it took to keep interest rates tightly pegged to very low levels to facilitate war and reconstruction funding. The recent QE has not been such a straightforward exercise. Rather than being about facilitating fiscal policy, QE has been used as some sort of unconventional monetary policy that supposedly avoids the need for or works better than fiscal policy.

    To simplify the point, let’s just think about QE being done by buying zero coupon 30day treasury bills. Once such treasury bills offer zero or negative interest (as has recently been the case), do you still think exchanging those for bank reserves “reduces government debt”- or does anything else much?

    You are saying it is easy to print bank reserves, I’m just saying it is also just as easy to print treasury bills. Government deficit spending can be funded just as easily by printing either.

    PS. I don’t agree banks can “stoke inflation” by withdrawing cash from reserves. IMO the only way to stoke inflation is to relieve spending constraints on those who want to spend on stuff that has a restricted supply.

  44. ChrisA writes:

    Stone – I agree if the bonds are already zero interest and they do not need to be repaid – then no issue, they are not materially speaking a burden. But I don’t think most of the national debt is actually of this kind of debt, many of the current treasuries, while having a market yield which is very low, actually have a significant coupon. I think you are somewhat struggling to preserve your OP by introducing this example. My original point is that the QE approach is better than helicopter drops since it has the potential to reduce overall Government debt. I also pointed out that if QE by buying debt does not result in inflation, then the answer is, buy more, not less. I think these points still stand. To make the point even further, if you are worried that even after buying all the Government debt out there, we still don’t have inflation, well the CB can then go and buy other assets, like say company debt, then shares, then other countries debt, then real estate and so on. If no inflation, at least the Government would then have a nice portfolio of assets that we can all retire off.

    I am not sure what you mean by printing treasury bills? Yes the Government can create any amount of these it wants and also sell them, and them redeem them.

    On your final comment, surely if the banks are withdrawing reserves, it is to invest them in something, which means that they are increasing the money to buy assets, which means more money chasing the same assets, which means inflation.

  45. ChrisA writes:

    Stone – just to be clear, my view is that if the Government did try to fund itself through the printing press inflation would result pretty quickly. What I am trying to do, by reducto absurdum arguments, is to illustrate why critics of QE are wrong when they say it cannot create inflation. If the amount of QE we have done doesn’t create enough inflation, then the answer is to do more, not less, since the effects of QE are entirely benign as long as we stop doing it once the inflation rate reaches our target (actually I would prefer to use wage inflation rather than general inflation as the target but that’s a detail). The current “secular stagnation” fad in my view is almost entirely driven by the low inflation target we have in the West now. Almost all CBs are running below their target (driven by agency issues). We need to change this, and more QE is the most effective way of doing this in my view.

    But, if inflation were at 7% and heading to 10%, my view would be absolutely the opposite.

  46. Southwest Steve writes:

    Has anyone else looked at the Econtrarian by Paul Kasriel. He says QE works through the creation of “thin-air” credit. “This is credit that is created figuratively out of thin air. When central banks purchase securities in the open market, such as they do when they engage in quantitative easing (QE), they create credit out of thin air. When the depository institution system expands its loan and securities portfolios, it creates credit out of thin air. Credit created out of thin air enables the borrower to increase his/her current nominal spending while not requiring any other entity to reduce its current spending.”… “Had the Fed not engaged in QE, U.S. total thin-air credit growth would have been quite weak, similar to what the eurozone has experienced…. weak depository institution thin-air credit creation is not so much related to lack of demand for it, but rather depository institutions’ inability to supply demanded credit. Following the bursting of the residential real estate bubbles in the U.S. and the eurozone, depository institutions experienced a severe “evaporation” of capital. Because of capital constraints, depository institutions were not able to expand their holdings of loans and securities.”…”the Fed’s engagement in QE and the ECB’s lack of QE account for the difference in the performance of the U.S. economy vs. the eurozone economy since 2008.” Before retiring, Kasriel was chief economist at Northern Trust

  47. stone writes:

    ChrisA@46, I think you have focussed it well when you state, “if the Government did try to fund itself through the printing press inflation would result pretty quickly.”

    Just to clarify, you are saying that (hypothetically) if the government were to fund the deficit by simply spending government money into existance (and so increasing the stock of bank reserves), then that would be more inflationary than if it were to instead fund that deficit by issuing zero coupon 30day treasury bills with zero interest.

    That key point is what I don’t get. As far as I can see, once there are enough bank reserves for interest rates to fall to zero, then enough is enough and nothing comes from having more. Once a glut of money is being held as a store of value (rather than just as a medium of exchange), then it makes little difference whether it is held in the form of treasury bills or as bank reserves. Let’s imagine an insurance company has say $1B as treasury bills, then you get control of the central bank and decide to try and increase inflation by exchanging those for government money. So the insurance company ends up with $1B on deposit mirrored by $1B in bank reserves at the insurance company’s bank. Is the insurance company going to behave any differently as a result? How is inflation going to be induced?

    By the way, have you seen this:
    I’m wondering wether you have a different view of monetary operations than that? That link pretty much tallies with how I was thinking things were working -except that I don’t get their view that QE necessarily leads to portfolio rebalancing.

  48. JKH writes:

    “On the monetary-ish side, we could choose to pursue a higher inflation target or an NGDP level path (either of which would, like QE, require supporting nominal asset prices but would also risk impairment of their purchasing power).”

    NGDP level targeting intersects with QE – apparently – according to the descriptions of it offered by its proponents

    That’s the problem with it – the mechanism to achieve the target is as problematic as QE itself

  49. ChrisA writes:

    @Stone – I will have to leave this discussion unfortunately, as the day job is calling. So a very simple last comment – the arguments that you (and the linked article) are essentially making is that QE so far has not been particularly stimulating since most of it has been sterilized are arguments for doing more QE not less. There are no downsides if you are below your target, in fact plenty of upside as it retires Govt debt.

    Final note – the power of QE, as very eloquently expressed by Nick Rowe as the Chuck Norris effect, is magnified immensely by expectations. So if you are really concerned to minimize QE, announce that you will continue to do QE until inflation (or better still wage inflation or NGDP) is back above the trend line from before the recession. And this QE will not be undone unless you exceed that trend line.

  50. stone writes:

    ChrisA@50, I guess I’m not so much saying that QE hasn’t been stimulating because it has “been sterilized” as that it hasn’t been stimulating because it is inextricably sterile once interest rates are at the zero bound.

    You can say that you will continue to do QE until wage inflation is at target but that doesn’t mean that QE will have any capacity to induce wage inflation or NGPD growth or whatever. It may be like King Canute trying to command the tide.

    QE isn’t benign if policy makers fall back on the (false) promise of QE rather than getting to grips with policies that could actually get the economy working again. I agree that it is harmless to conduct rain dances or whatever when they are attempts to influence something that can not be influenced (such as the weather). The tragedy though is that we do have the capacity to greatly improve our economy but we shirk that responsibility because it is politically awkward to deal with whilst QE (being meaningless) offers no political obstacle and lets policy makers ‘look busy’.

  51. reason writes:

    ChrisA @38
    What are we trying to do here? Reduce the debt or improve the welfare of the people?

  52. reason writes:

    P.S. I get a bit suspicious of arguments that when doing something massively doesn’t have the desired effect, doing it more massively will. It is possible, but I really want to see the mechanisms functioning. I also think running up large liabilities may be a politically bad idea (it enables anti-stimulus forces to point and say THE DEBT, THE DEBT… ), but surely having a large debt at a small coupon is no great future liability, the Fed is not in the business of politics and the unemployed really can’t wait for a policy that has been going to work any day now for years.