Note on quantitative easing


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Note written by an ‘in paradigm’ associate:

Growth in the size of the Fed’s balance sheet indicates that it is acting as a financial intermediary, but it doesn’t say anything useful about real economic activity or prospects for inflation. Even when the Fed buys Treasury debt from the private sector in return for cash, it is only substituting one financial claim on government for another of identical nominal value. This transaction doesn’t change the net financial assets of the private sector – so there is no obvious economic impact. Similarly, the Fed can encourage or even require banks to hold more and more excess reserves, but to what end ? Bank lending is not constrained by a lack of reserves, it is limited by capital ratios and the opportunity set for profitable lending. In this context, reserve growth increases gross balance sheets, but has no economic consequences.

What might be said about quantitative easing (QE), is that the Fed has to bid up bond prices (forcing yields down)in order to acquire Treasuries in the secondary market. At the margin, this has the potential to induce changes in portfolio preferences and push investors into more risky assets. So, QE might have some second order effects on financial assets prices, but still no logical or direct connection to generalized price inflation.

Some potential causes of inflation going forward might include sustained fiscal stimulus of sufficient proportion to more than offset the spontaneous decline in private sector demand that we are witnessing. If this were to use up existing capacity, then the probability for inflation goes up. Furthermore, even before we reach full capacity domestically, some of the growth in aggregate demand will leak overseas. Many of our imports have low elasticities and their prices could rise quickly. The most obvious example is crude oil. This would result in upward pressure on reported inflation even with broader economic growth below trend. In other words, a partial recovery of aggregate demand without energy policy reform could be inflationary.

I would hasten to add that none of this is original thinking and most of it is common sense. I found it odd that so many of the brilliant and successful people that you assembled last week relied on vague notions of “monetarism” or “Keynesianism” to frame their views and reverted to jargon rather than analysis to argue their points.


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Back from a week off


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Been away for a week.

First impressions:

Seems world fiscal responses both automatic and more recently proactive have turned the tide.

Looking for a quick return to positive GDP (from very depressed levels) helped by very low inventories in general.

But relatively slow returns to ‘normal’ in many sectors as well.

And central banks doing a lot of foot dragging regarding rate hikes due to large continuing output gaps (high unemployment).

The eurozone lags as it’s passed on proactive fiscal measures and instead is waiting for exports to pick up, and makes these kinds of counterproductive noises:

“The European Union (EU) has officially opened the excessive deficit procedure against Ireland, Greece, Spain and France since their budget deficits shot up beyond the EU’s limit amid the financial crisis.

The decisions, which were taken by EU foreign ministers in Luxembourg on Monday, required the four countries, as well as Britain, which had been under the excessive deficit procedure, to take corrective actions to rein in their deficits by Oct. 27, 2009.

Under the EU’s Stability and Growth Pact, all member states have to keep their budget deficits below 3 percent of their gross domestic product (GDP).”

Q1 Earnings generally better than expected.

This is all very good for US equities.

A few selected somewhat positive headlines from the past week with the most recent on top:

Malaysia Keeps Interest Rate Unchanged as Export Slump Eases
South Korean Current Account Rises, N.Z. Exports Gain
China’s Economy Recovering on Investment Surge, Citic Says
European Retail Sales Decline Least in 11 Months
European Confidence Rises for First Time in 11 Months
ECB’s Wellink Doesn’t See ‘Real Deflation’ in Europe
Tumpel-Gugerell Says ECB Sees No Deflation Risk, Badische Says
Germany’s Economy to Return to Growth Next Year
B0E spots hopeful economic signs
U.K. Has Biggest Budget Deficit Since World War II
U.K. Mortgage Lending Rose 16% in March, CML Says
Industrial Production Index Seen Up For 1st Time In 6 Months
Govt Submits Record Extra Budget For FY09 To Finance Fresh Stimuli
China’s External Demand Showing Signs of Recovery, Sun Says
China to launch more stimulus investment in second quarter
China Central Bank’s Yi Sees Signs of Economy Rebound
WB official: China a ‘bright spot’ in 2009 world economy


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2009-04-29 USER


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MBA Mortgage Applications (Apr 24)

Survey n/a
Actual -18.1%
Prior 5.3%
Revised n/a

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MBA Purchasing Applications (Apr 24)

Survey n/a
Actual 251.60
Prior 253.00
Revised n/a

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MBA Refinancing Applications (Apr 24)

Survey n/a
Actual 5108.20
Prior 6540.70
Revised n/a

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GDP QoQ Annualized (1Q A)

Survey -4.7%
Actual -6.1%
Prior -6.3%
Revised n/a

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GDP YoY Annualized Real (1Q A)

Survey n/a
Actual -2.6%
Prior -0.8%
Revised n/a

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GDP YoY Annualized Nominal (1Q A)

Survey n/a
Actual -0.5%
Prior 1.2%
Revised n/a

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GDP Price Index (1Q)

Survey 1.8%
Actual 2.9%
Prior 0.5%
Revised n/a

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Core PCE QoQ (1Q)

Survey 1.0%
Actual 1.5%
Prior 0.9%
Revised n/a

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Personal Consumption (1Q)

Survey 0.9%
Actual 2.2%
Prior -4.3%
Revised n/a

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FOMC Rate Decision (Apr 29)

Survey 0.25%
Actual 0.25%
Prior 0.25%
Revised n/a


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