Why I Do Not Like QE2-Becker

 

 

Other governments, and their central banks, have reacted vocally and negatively to the Federal Reserve’s plan for another round of quantitative easing-which means that the Fed purchases long-term bonds. These negative reactions to QE2 outside the United States are presumably motivated by their self-interest, but I believe that another large-scale Fed purchase of bonds is also against American interests.

One justification frequently given for further Fed open market operations is that it will increase bank lending through raising bank reserves (“high powered” money). The reluctance of banks to lend has clearly been a factor in the slow down in the US recovery. Yet the Fed’s creation during the past couple of years of well over trillion dollars in additional reserves through open market operations has not induced rapid increases in bank lending. Instead, banks have accumulated huge amounts of excess reserves; that is, reserves above the amount they are required to keep as collateral for their deposit liabilities.

Given that banks already are holding such large reserves that carry low interest rates, it is hard to see why creating additional reserves will stimulate much additional lending. The big constraint in the lending market is that both borrowers and lenders perceive considerable risk to investments. This is partly due to government policies, like the health care and the financial reform bills, and proposals to raise taxes on higher incomes and on capital gains that will raise costs of doing business, and lower after-tax incomes of investors. Perhaps that perception will change due to the recent election of many Congressmen who say they want to lower taxes and reduce the size of government, but this perception of a risky investment environment will not change because the Fed creates large quantities of additional reserves.

The eventual inflationary impact of QE2 is another reason to be skeptical about its desirability. Before too long the US economy is likely to recover at a faster pace, and bank lending will then increase by a lot. At that time, the reserves created by the Fed will be converted through increased bank lending to businesses and households into money, such as currency and demand deposits. This growth in the money supply will create far more inflation than the Fed desires, unless the Fed dampens the growth by large scale selling of much of the several trillion dollars of assets it accumulated during the financial crisis.

The Fed does have the tools to control the resulting increase in inflation through selling these assets and reducing bank reserves. However, it is problematical whether it will have the political will to do that. Any large effort by the Fed to sell assets and reduce reserves will not only dampen the inflation rate, but the real economy as well. As a result, the Fed will be under strong political pressure to reduce their open market operations. Whether the Fed succumbs to that political pressure depends on Chairman Ben Bernanke’s willingness to fight the political battles.  Perhaps he will, but my guess is that a compromise will be reached whereby the Fed will tighten but less than it would like. The end result will be a greater rate of inflation than is good for the economy.

Central banks and other participants in currency markets are expecting an eventual significant increase in prices in the United States. This is why they have been trying to reduce their holdings of dollar-denominated assets that would decline in real value with inflation. These efforts in turn lower the value of the dollar relative to the euro, yen, and other currencies. Until the inflation rate actually increases by a lot, this reduction in the exchange value of the dollar reduces the prices of US goods in the international market. This in turn stimulates the demand for US exports, and reduces the demand by American consumers for goods made abroad. However, once inflation actually takes off, the process will tend to be reversed: demand for US exports would decline, and American demand for imports would go up.

In justifying the planned purchase of hundreds of billions of dollars of long-term bonds, Chairman Bernanke indicated that the goal is partly to lower long term interest rates relative to short term rates- which are already close to zero- and thereby stimulate longer term investments. A large purchase of long-term bonds would indeed lower long term rates relative to short -term rates, but the effect is not likely to be large. The reason is that long -term interest rates are essentially a weighted average of current and expected short-term rates, adjusted upwards for the greater riskiness and lower liquidity of long-term bonds. That is to say, the long-term shape of the interest rate yield curve is mainly determined by these fundamentals, and it is much less affected by changes in the relative supply of short and long-term assets.

Fed Chairman Bernanke wrote in an article in the Washington Post on November 4^th that "The Federal Reserve cannot solve all the economy's problems on its own." The slowdown in the recovery of the American economy is not the result of Fed policy, and cannot be cured by yet another bout of open market operations. This is why the Fed should curtail, and better yet, eliminate its plans for QE2.

 

 

 

 

 

Comments

[air yeezy]

I will prepare and some day my chance will come.

[Jack]

"The reluctance of banks to lend has clearly been a factor in the slow down in the US recovery."

++++++ They've a structural problem don't they? If, as the Fed fears we're in a deflationary era housing prices and commercial R/E rents may fall with the borrower becoming "underwater". Business borrow for expansion, borrowing for contraction is ha! a form of selling out.

"The big constraint in the lending market is that both borrowers and lenders perceive considerable risk to investments."

+++++++++ Well close. In housing lenders "fear" continued deflation and combined with what happened in the zero down days insist on much higher downs, which the young prospective buyers (the only ones in the market just now) don't have.

Central banks and other participants in currency markets are expecting an eventual significant increase in prices in the United States. This is why they have been trying to reduce their holdings of dollar-denominated assets that would decline in real value with inflation.

+++++++ If they were dead wrong would it be a first?

Fed Chairman Bernanke wrote in an article in the Washington Post on November 4th that "The Federal Reserve cannot solve all the economy's problems on its own." The slowdown in the recovery of the American economy is not the result of Fed policy, and cannot be cured by yet another bout of open market operations.

+++++++ Indeed! But our erudite scholar of the Depression era sees far more risk of adding to the problem than that of inflation. And? just perhaps? he/they are enough of politicians to fire the first warning salvo that we aren't to be the dumping grounds for unemployment ills of the world even if our own WS thieves were the cause of the worldwide recession.

[Otto Veight]

Looking at the US from Asia:

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 altering the overall fundamental long-term motivation to produce.

Such a boat is the current US economy. People are being rewarded for rowing less while those that row harder or are working on new engine designs face an ever decreasing reward for their work. So, naturally, fewer and fewer people row and/or row less intensely. The boat is loosing speed. Meanwhile, macro-economists have rounded up various groups of passengers to blow on the sails of the ship as the last great hope to get the ship moving. While true appreciation of the futility analogy requires knowledge of elementary physics, most people will understand it at some intuitive level. So someone please make a cartoon…

The overriding reality is that the greatest payback (fame/money) for macro-economists 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, macro-economists manage to bamboozle a desperate electorate into believing that such attempts at 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 handout that they are offered.

Keep hoping though. One of these days economists will finally engineer the perpetual machine of prosperity: Then the HOPE of prosperity through CHANGE to lower incentives to produce will finally become reality!

The bottom line is:

Take the rewards of productive people and give it to less productive people: GDP drops. Because productive people modify their behavior (work less, retire earlier, take more unpaid leave, drop to easier/lower value work) while at the same time the less productive produce even less because direct and indirect subsidies insulate them more and more from the results of lower productivity.

For those that do not want to bury their heads in the sand there is only one option: The Western countries either remove these dis-incentives and resume growing at a rate of at least 4%, or the 1 billion people of the West become economically marginalized in a world of 6 billion people who are now growing at an average 4% annually, and 3 billion are actually growing at 5-10%. Growth is higher virtually everywhere else outside the Western world.

The West either abandons class warfare, or it joins the worldwide average. In relative terms this is a long-long way down from where the American middle class now stands. And the American lower class will long for the days when it was lower class in the most prosperous country in the world, as opposed to perhaps middle class in a middle of the pack country. Average per capita income in the world is less than $10,000/year folks. That’s where you’re headed in relative terms.

Don’t expect much to change. Therefore, Westerners, party while it lasts and prepare your family for descent to the worldwide average.

[D Stone]

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.

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[Jack]

Otto Veight? Is "viewing from Asia?"

And WHERE do you get this stuff??

"People are being rewarded for rowing less while those that row harder or are working on new engine designs face an ever decreasing reward for their work."

.............. Did you only recently wade through 1300 pages of Ayn Rand?

"The West either abandons class warfare,"

............ Class warfare? Working folk have been losing since 1980. One would HOPE it were over, or a truce declared, but the graphs tell us it's getting worse at ever faster ratesL

http://lanekenworthy.net/2008/03/09/the-best-inequality-graph/

"The Western countries either remove these dis-incentives and resume growing at a rate of at least 4%, or the 1 billion people of the West become economically marginalized in a world of 6 billion people who are now growing at an average 4% annually, and 3 billion are actually growing at 5-10%. Growth is higher virtually everywhere else outside the Western world."

............ sorry, "Asia" but it gets harder to maintain such growth rates as we mature and our "best and brightest" become ever more greed-ridden and corrupt. Hey! how on raising pay over there and selling Walmart goods to each other?

BTW I wish all those developing nations the best and hope they can and will bring their living stds up, but! I don't think it's a GDP race. Also, I'd warn that there's only so much Walmart stuff a mere 300 million of stagnant wages, and HIGH unemployment want or can buy. Maybe send us a million or so docs and nurses though, we've really got to pound down these H/C costs!

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[Mahesh Thatte]

Most of the extra money will fizzle as investment flies overseas, as people who expect some reward from saving (delayed gratification) seek the higher returns that Americans seem no longer willing to put the effort to produce. And pity the US if savers worldwide decide its no longer worth doing so. So QE2 is not going to help the US much, and whatever little gain will be more than negated by the adverse consequences.

All this because, in layman’s terms,

Macroeconomic manipulations on a populace that has lost incentive to produce more, is akin to squeezing a balloon. American people just have less incentive to produce than they had a few years ago. Those who produce little are being subsidized, while those who produce face pitchfork economics. Bottom line, less incentives to produce for everybody, rich and poor. Less production = less wealth, almost by definition. There is no need to resort to elaborate economic jargon to explain the source of America's descent to a lower growth trendline.

Times have changed dear Americans. Billions of people have finally found enough economic freedom to compete with you just by virtue of our numbers and our newly found, albeit limited economic freedom. Meanwhile, you are retreating from the principles that once separated you from the rest of us. Good luck, we wish you well, because you were the ones that taught us the benefit of individualism in the first place.

[D. S.]

Jack, your working folk has become somewhat complacent as you are apparently becoming a walfare state and thus your working folk has not adapted enough. Your working folk demand they earn American wages and have a western standard of living doing the same work that 3 billion people on this planet can now do. By now turning on your innovators and entrepreneurs, your working folk will capsize the whole ship. Europe is already taking in serious water.

- Working folk earning American wages doing stuff that 3 billion people can do and
- American innovators and entrepreneurs having no more incentive to be exceptional than their counterparts in competing countries.
So what is there left? What is there left that justifies exceptional American prosperity? Or are you the smarties who have discovered the perpetual motion machine that earns you disproportionate prosperity when there will be little exceptional about you any more?

I saw this coming, that’s why I did my stunt in America and got out. Come to Asia and see how you are appreciated as an enterpreneur… It ain’t worth trying too hard in America any more. And it’s going to get worse. A lot worse… By the time the average Chinese produces just 25% of what the average American produces, China will have overtaken the US as the largest economy in the world. And I’m not even counting India and other ascending people.

[Otto Veight]

For all practical purposes, the FED’s money printing is essentially an orderly partial American default: Dilute all debt held in dollars as well as cash held in dollars whether held domestically or internationally. Americans are perhaps playing one of their last cards on their way to what now seems an even more precipitous decline. This last card is credibility.

Once credibility is lost it will be very difficult to regain. Add to that the downward spiraling caused by the vicious cycle whereby “The more voters hurt the more central planning and redistribution they will vote for in their desperation” and you see how close to the point of no return America really is. Fooled by HOPE of prosperity through CHANGE to lower incentives to produce, Americans may have already gone past the point of no return. The steep ride to the Valley of Mediocrity now awaits.

While past mistakes brought America closer to the rest of the world, America was endowed with such a disproportionate amount of personal freedom at its creation that it always maintained a personal freedom edge over the rest of the world. But all these past mistakes have now accumulated to the point where the American margin of advantage is now thin. At the same time, the rest of the world has awakened to the benefits of economic freedom. So things are different now. Americans have finally arrived close to parity in production incentives with the rest of the world (definitely so for those who live in high tax states such as California and New York). With Obamacare kicking in full force in 2014 America’s fate of decline seems all but sealed. So make plans. Pitchfork economics are coming.

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[Jack]

Jack, your working folk has become somewhat complacent as you are apparently becoming a walfare state and thus your working folk has not adapted enough.

+++++++++++++ Seemingly false. Any support for your .......theory?

Your working folk demand they earn American wages and have a western standard of living doing the same work that 3 billion people on this planet can now do.

+++++++++ Largely wrong. US wages have been flat for decades with the least among us losing PPower. Have you noticed what the bosses and owner set are demanding?

http://lanekenworthy.net/2008/03/09/the-best-inequality-graph/

+++++ BTW quick econ exercise: As $18 is required to maintain the most modest level of independent living and increasingly our jobs are not paying that much, how do you suggest closing the gap? Govvie transfer programs? Multiple jobs when we're short 15% already? Stealing and vice? Other?

By now turning on your innovators and entrepreneurs, your working folk will capsize the whole ship.

++++++++++ Oh.

Europe is already taking in serious water.

++++++++++ Aren't we all after the rabid foxes were allowed to raid our henhouses and seed corn stores for ten years? Did you hear the echo of the financial crash over there?

- Working folk earning American wages doing stuff that 3 billion people can do and

+++++++++++ Ummm "interesting". TRUTH is US per capita GDP continues to grow. Trouble is those doing the work are not sharing in the proceeds.

- American innovators and entrepreneurs having no more incentive to be exceptional than their counterparts in competing countries.

++++++++++ After reading the above what do you think the incentive for the American worker to work is?

So what is there left? What is there left that justifies exceptional American prosperity?

++++++++++ A democracy and a largely free press. After as Winnie Churchill said we try everything else we'll get it right.

Or are you the smarties who have discovered the perpetual motion machine that earns you disproportionate prosperity when there will be little exceptional about you any more?

++++++++++ Haha! I've heard it said that the success of Silicon Valley relies heavily on our Asians being smarter that your Asians. What do you think?

I saw this coming, that’s why I did my stunt in America and got out.

++++++++++ Umm....

Come to Asia and see how you are appreciated as an enterpreneur…

++++++++++ Sorry. I've been to Asia and enjoyed it, however most of my entrepreneurial days are behind and I'm enjoying the splendor and wealth of Alaska........ back when the Japanese were rich many of them liked to come and enjoy our great state too, even spoke of locating plants here. But......... that was then.........

It ain’t worth trying too hard in America any more. And it’s going to get worse. A lot worse…

++++++++++ Depends.

By the time the average Chinese produces just 25% of what the average American produces, China will have overtaken the US as the largest economy in the world.

+++++++ Indeed, your arithmetic seems about right. After spending time in Korea in their poor post war era I have cheered their energetic rise to being a relatively wealthy society, and a much better neighbor than NK. Likewise I hope the best for the Chinese and it DOES indeed seem that the cost of a high std of living for a billion three will take quite a bit more than for our .3 billion, eh?

And I’m not even counting India and other ascending people.

+++++++++ Indeed! I've close Indian relatives now and wish the very best for those smart and hardworking folk too...... interesting how there are Indian restaurants every where I travel these days.

[Jack]

Keynesian econ equation for the day:

As our Feds put out an $800 billion stimulus, not entirely deployed as yet, and our beleagured cities, counties, and states have necessarily cut an equal amount what is the net stimulus?

After arriving at the answer please adjust for:

A. the American consumer feeling poor due to R/E, and retirement account equities having been lost entirely or halved.

B. the 10% unemployment and 18% "underemployment" with one in three households being impacted by the loss of a job since the financial sector melt down.

Post net-net "stimulus" here:

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Good at planning, good at time management.*

[Luke H Lee]

Even if we adopt more quantitative easings, we can only postpone the inevitable deep economic decline. They are not the solutions for the current economic crisis.

Many experts are trying to solve the current economic crisis but it seems to no avail. It looks as if our economy is inextricably tied to a wider series of economic problems such as the housing market collapse, sub-prime mortgage system failure and financial market meltdown. And now those problems have catapulted us into what may be a deeper recession – high unemployment and a virtual retrenchment in new business development. In other words, it looks as if we are faced with a situation that would make the Gordian knot seem like child’s play. I believe the “knot” can be untied only by an Alexandrian Solution, not the conventional solution that we have turned to in the past to jumpstart a flagging economy mired in recession.

If we can create many new jobs in the market, I believe we can easily free our economy from the current economic malaise. I’m not just talking about thousands of jobs, but millions of jobs.

Suggest to see:
Overcoming an Economic Sisyphean Task – Or, the Tr... http://t.co/mLhDkDP
A Real Stimulus and Rescue Package http://t.co/q2L1qFb

[Otto Veight]

I thought at least a few people would be fooled and there're be at least some short term effect from the FED's newest transfer of money from one pocket to the other. But aparently not. Not enough foolish bond investors, so bond yields are rising and prices dropping:

http://online.wsj.com/article/SB10001424052748703326204575616321781875884.html?mod=WSJ_hp_LEFTWhatsNewsCollection

I guess perhaps this new attempt at the perpetual motion machine of prosperity whereby Americans prosper through lower incentives to produce, ain't working either. What a surprise!

[D.S.]

Jack, Nobody wins votes by telling the working folk that their skills are out of line with their worldwide wages and that they need to either accept lower pay or move to higher value work, i.e. take responsibility, make sacrifices now and become personally more competent.

So exactly because nobody wins votes by pointing out these things, that is why the situation is not rectifiable and America's path to decline is irreversible. The working folk will finally respond at the polls. However history in every other country that has taken this path of HOPE and CHANGE, tells us, that: Voters, once past the tipping point, will always do too little too late. They will merely slow down the decline as they did in this last election. They will not reverse it. They will keep predominantly HOPING that CHANGE to lower incentives to produce will make them better off. When they see that this does not work they will vote - for too little too late, only to relapse to HOPE and CHANGE shortly after in desperation.

As someone already pointed out, the cycle ends when the American middle class finds a new equilibruum - at the same level as the worldwide middle class.

[Jack]

D.S. Admittedly the Tea Partiers found their votes with vague promises of (painlessly) cutting the Fed budget, but regular Republicans seem fond of denigrating the skills and worth of working folk.

It's a "funny thing" that "conservatives" (crony caps?) who venerate "the market" and "biz" now expect the voter and government to define the needed transitions. Also a "funny thing" that industry leaders HELPED fly us up a blind canyon of over dependence on oil along with the "best and brightest" financial sector geniuses.

Not sure what your obsession with "lower incentives" is, but the way out is not grunt work and low wages but but both government, business and the people working together to move us from wasteful corruption and crony capitalism to efficient use of our resources and deploying them in a direction relevant to a rapidly changing era.

[D.S.]

Jack, working together means that come 2014 I drop my contribution to GDP below 88k per year, retire early and leave you stuck with the bill for my healthcare premiums. Then you can battle doctors for regulated lower salaries and patients for more rationed care so that your taxpayer costs for my family’s healthcare drop from 15k to 10k. I bet that will make you wake up and go to work enthusiastically every morning. And remember, you have to make up for the difference between my current income and $88k to keep America’s GDP just even.
But, of course, it would be unethical for me to mooch off taxpayers like that so I will not do that. Nobody will. It’s a CHANGE but I HOPE it will work. America survives and prospers.

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Uh, oh. Sending good vibes to you!

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Your essay is good except for some spelling mistake.

[Jake]

Hopefully Professor Becker and Judge Posner find some amusement in the rantings above.

[Jack]

D.S. Not sure if you're claiming that a 3% rate hike on the amount over $250k is enough to cause you to make truly dramatic lifestyle changes, but! advisors these days recommend not retiring too early and especially not if you expect high inflation combined with miserly market or bond returns.

But it is up to you....... as demand drives what's left of our once fine economy, I'm sure that what "GDP" you opt to leave lying around on the table will be snatched up by younger energetic folk with few other options.

I'm not sure how you're planning (hoping?) to export your family's H/C costs to me or anyone else; perhaps you can clarify?

Lastly it does look as though CHANGE is upsetting to you, and little wonder, as gridlock and stagnation has long delayed bring our nation into the modern "global" era. BTW......... do you think medical bankruptcy, virtually unknown in the civilized nations, but number ONE here, is an efficient or humane use of scarce resources? Thanks, Jack

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