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Quantitative easing
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.
Posted by Tyler Cowen on March 19, 2009 at 08:22 AM in Economics | Permalink
Comments
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.
Posted by: unseen at Mar 19, 2009 8:53:34 AM
I looked up M2 at the St Louis Fed. Apparently this is just about 12% of the current M2. Therefore, in approximation, if GDP shrinks by 5% this year and the money velocity remains unchanged inflation will be about 17%.
Posted by: Neal at Mar 19, 2009 9:03:36 AM
did not seem incredibly effective
What does that mean?
Posted by: floccina at Mar 19, 2009 9:04:11 AM
how much "more likely" ? Put a number on it!
Posted by: blank at Mar 19, 2009 9:10:46 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.
Posted by: MostlyAPragmatist at Mar 19, 2009 9:22:35 AM
Tyler,
Do you really expect the money to be withdrawn in the future? Does anyone?
Posted by: Yancey Ward at Mar 19, 2009 9:37:41 AM
Sitting in an airport... waiting for the helicopter
Posted by: Tadhgin at Mar 19, 2009 9:55:16 AM
Creating the money is only half of the equation. What just happened is the leash on Obama and Pelosi was just dropped and they're able to run wild now on an unlimited spending spree.
I think the budget deficit this year will blast past $2T easily. As there is no one left standing who can buy our debt other than the Fed, it seems that this firehose of cash was just the start. It's even worse than that because this move removed the constraints on spending. The money is free and the politicians can hand it out in buckets to anyone they want.
The Fed will have to do this again and again and again ...
Posted by: K T Cat at Mar 19, 2009 9:55:22 AM
Why now?
Posted by: odograph at Mar 19, 2009 10:07:45 AM
"It may introduce a round of "beggar-thy-neighbor," central bank-engineered currency depreciations."
This is a feature, not a bug.
One of the main imbalances in the economic situation is that the US was spending somewhere in the order of $800 billion more than it earned each year while others, especially China, Japan, Germany, and OPEC were earning far more than they spent.
We can not achieve a stable equilibrium until this is resolved. That means others have to increase spending while in the long term we need to reduce it.
With an aggressive US fiscal policy these other nations can, and will, freeload off US stimulus. This is because it tends to increase the value of the dollar. While US fiscal policy can ease the transition costs of moving to a new equilibrium we will never achieve one with the US acting alone solely with fiscal policy.
Monetary easing decreases the value of the dollar and does not allow others to freeload.
If they want to avoid long slowdowns they need to take action to stimulate their own demand.
"central bank-engineered currency depreciations" is a perfectly valid way to do this.
Posted by: dk at Mar 19, 2009 10:25:04 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 Perón 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.
Posted by: E. Barandiaran at Mar 19, 2009 10:53:46 AM
Tyler, what specific "sectoral shift" are you talking about? The housing bubble or something more fundamental?
Posted by: a_c at Mar 19, 2009 11:15:59 AM
Interesting take: "...this should have been our first move...Monetizing ... government debt is what Third World nations do"
Posted by: mulp at Mar 19, 2009 11:22:37 AM
Let's face it: a significant rise in inflation is inevitable. Instead of trying to get everyone to reduce the price of the so-called "troubled assets" they will be devalued by a reduction in the value of the currency accompanied by an increase in the price of consumables and commodities (but no accompanying rise in the price of housing or other fixed goods). The net result is you've dropped the value of the "overpriced" assets relative to other parts of the economy without anyone having to have written anything down.
Much more effective than trying to coerce banks into renegotiating loans, IMHO. As long as your assets are structured so as to minimize the net impact of inflation -- or if you have no assets, but are rather living on wages which will increase far more rapidly with inflation -- you should be fine. Holders of capital assets will be impacted, but they are already underwater, even if they have not yet recognized this fact on their balance sheets.
Posted by: Mark at Mar 19, 2009 11:45:54 AM
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?
Posted by: Jason (the commenter) at Mar 19, 2009 12:23:26 PM
I looked up M2 at the St Louis Fed. Apparently this is just about 12% of the current M2. Therefore, in approximation, if GDP shrinks by 5% this year and the money velocity remains unchanged inflation will be about 17%.
Why M2? This new money will contribute directly to M1, if not the monetary base itself. Most recent M1 value from St. Louis (http://economagic.com/em-cgi/data.exe/fedstl/m1ns+1) is $1.5345 trillion, of which Bernanke's helicopter-drop represents 65%!
Hold on to your hats, the inflation rocket is taking off.
Posted by: Noah Yetter at Mar 19, 2009 12:44:58 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.
Posted by: Gabe at Mar 19, 2009 1:26:21 PM
On ethical and economics ground I favor a REAL helicopter drop.
These fake "helicopter" drops lack the distributional equity -- and publicly observed non-equity -- of the bogus helicopter drop.
People need to SEE what is happening. Actually helicopter drops would do that.
Posted by: Greg Ransom at Mar 19, 2009 3:09:24 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.
Posted by: Lord at Mar 19, 2009 3:09:46 PM
Well the US is behaving like a third world country so maybe this would work!
Posted by: SA at Mar 19, 2009 3:25:10 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!
Posted by: monopolyman at Mar 19, 2009 5:29:26 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."
Why is that? The Fed is increasing M to counteract a drop in V, correct? So what happens when velocity picks up again?
Posted by: Dan at Mar 19, 2009 5:48:01 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.)
Posted by: Scott Sumner at Mar 19, 2009 6:12:07 PM
Why M2? This new money will contribute directly to M1, if not the monetary base itself. Most recent M1 value from St. Louis (http://economagic.com/em-cgi/data.exe/fedstl/m1ns+1) is $1.5345 trillion, of which Bernanke's helicopter-drop represents 65%!
M2 because IIRC that's what the Fed considers "real money". Since M1 is a subset of M2, if M1 increases by $980bn, won't M2 also increase by that? I would think that the multiplier for M2 is also very near one.
Posted by: Neal at Mar 19, 2009 6:56:23 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.
Posted by: Jason (the commenter) at Mar 19, 2009 7:32:14 PM
