A few thoughts on the Fed’s quantitative easing strategy
I am on holiday for a few weeks. But I am going to write a brief post here on QE because I think it is an important subject. For months now we have heard that the Federal Reserve could start buying up Treasury securities in another round of so-called quantitative easing.
The St. Louis Fed’s James Bullard telegraphed the Fed’s intentions in his piece Seven Faces of The Peril? last month. So, what should we expect now that the Fed is all-in for printing money?
Well, first of all, many prognosticators are calling this QE lite. This is not the expansion of the Fed’s balance sheet to $5 trillion as pundits like Ambrose Evans-Pritchard were calling for. Nor is this a buying of long-dated Treasury paper by the Federal Reserve. Nor is the Fed buying up municipal bonds. The Fed is not even doing credit easing as it did the last go round in which it focused on the asset side of the balance sheet, making it distinct from quantitative easing (I called this qualitative easing). So, this is QE-lite indeed.
Will it work though?
As Bill Clinton might say, It depends on what "work" means. Here’s what I said last month:
- QE is just a shuffling of net financial assets. It’s basically an asset swap since T-bills yield next to nothing. Get ready for another pile up of excess reserves.
- QE could work well in inflating asset prices more than consumer prices – but that could serve the Fed’s purpose too.
I have always viewed QE with scepticism. It wasn’t effective the first go round exceptregarding asset prices. And I don’t see QE preventing a slowdown in growth in the US this time either. That means yields will remain low.
But, if you are thinking QE is going to have an appreciable effect on the real economy, think again. Tyler Cowen puts it well:
I don’t buy the idea that so many of the unemployed are stupidly and stubbornly holding out for a higher wage than they can get, while at the same time they can be reemployed by a mere bit of money illusion. There are so many blog posts written to the Fed, to Bernanke, etc. "Hey guys, goose up the money supply! Bernanke, read your old writings!"
Yet I have seen not one such post to the unemployed: "Hey guys, lower your wage demands! It’s good for you! You’ll get a job and avoid the soul-sucking ravages of idleness. It’s good for the country! It’s good for Bernanke, you’ll get those regional Fed presidents off his back! Why not? The best you can hope for is to get tricked by money illusion anyway! Show up those elites and get to that equilibrium on your own! Take control!" and so on. If such posts would seem patently absurd, we should ask what that implies for our underlying theory of current unemployment.
I sooner think of these unemployed individuals as having gone down economic corridors which are no longer promising and not facing any easy adjustment to set things right again. Furthermore I consider that portrait of their troubles to be more consistent with the general tenor of liberal, left-wing, and progressive thought, not to mention plain common sense.
Elsewhere, Matt Yglesias has an interesting post on the recalculation argument and its relation to political ideology. He claims that promoting the argument will make people like capitalism less and that may well be true. I would add:
- The Industrial Revolution also was a tough slog for quite a few decades. Yet it was both worthwhile and it gave capitalism a bad name for a long time.
- Alexander Field argues that the Great Depression brought greater productivity improvements than any other decade in U.S. history.
- If one wishes to consider state intervention, in light of recalculation, one is pointed in the direction of direct employment of the struggling workers; the recalculation argument does not rule out intervention per se. This advice could potentially be useful and I don’t see why even libertarians should consider it necessarily worse than $800 billion of fiscal stimulus.
- Like Matt and many others, I favor a more expansionary monetary policy. But the last stimulus was oversold and there is no reason to oversell this one. We really don’t know how well it will work (and I’m not referring to liquidity traps). But if the Fed tries more monetary expansion, we’ll see how much of the current employment is cyclical and AD-related in the traditional sense.
- By its very nature, a recalculation argument ought to be somewhat agnostic as to how much (and what kind) of recalculation is actually required. See #4.
See my posts on recalculation aka structural unemployment due to malinvestment here and here. The upshot of those posts is that QE-lite will have an appreciable impact on the economy only insofar as it prevents asset prices from deflating. But the asset-based economic model is now losing its vigour. This only reinforces the status quo ante and retards recalculation. As I have mentioned previously, the private sector is not hiring. I agree with Tyler Cowen that, If you really want to speed up recalculation, the statist approach of direct employment may be the only thing left. See my post Unemployment insurance for the 21st century.