Note on quantitative easing


[Skip to the end]

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.


[top]

This entry was posted in Daily and tagged . Bookmark the permalink.

3 Responses to Note on quantitative easing

  1. Captain CraZ says:

    “Similarly, the Fed can encourage or even require banks to hold more and more excess reserves, but to what end ?”

    So that when they go off mark to make believe accounting and go back to something closer to mark to market, they can survive when the level 3 assets are properly accounted for.

    “Bank lending is not constrained by a lack of reserves, it is limited by capital ratios and the opportunity set for profitable lending.”

    Bank lending is not even constrained by profitable lending, the illegal mexican who got loans for his big truck from his cousin the latino loan officer is laughing at you guys. The loans were never meant to be profitable long term or ever repaid fully. Warren Mosler looked at some old lady who wanted to buy a lawn mower and was conservative with his decision, but even this his boss told him to make the loan, sadly I have known many loan officers who were much more gung ho and corrupt than Warren Mosler.

    “In this context, reserve growth increases gross balance sheets, but has no economic consequences.”

    My banker friends on the golf course don’t want to lose thier nice banker jobs, if level 3 assets were properly accounted for and they didn’t have reserves to cover that, they might have sheila bair kicking them to the unemployment line and giving all thier companies to ken lewis.

    “potential to induce changes in portfolio preferences and push investors into more risky assets.”

    LOL! BWAHAHA! All my rich palm beach friends already have had to downgrade from the latest mercedes because they were in bed with bernie madoffs and his corrupt ponzi clones. They all swear to me now RISK is for suckers and they would rather earn negative 5% a year on treasuries than -50 or -100% trusting wall street crooks ever again and thier financial innovations!

    “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.”

    I thought shopping machine princess was calling sole and mia to go on some more shopping trips and private sector demand was ticking back up? We can’t let those shopping malls go bankrupt and lay empty in the heart of our cities.

    “Many of our imports have low elasticities and their prices could rise quickly. The most obvious example is crude oil.”

    http://www.reuters.com/article/rbssEnergyNews/idUSLT87170020090429
    The crude market is in contango, a condition where today’s prices are lower than future prices. A company with access to storage can buy oil and simultaneously enter into contracts to sell it in the future, locking in a profit.

    That encouraged trading firms to store millions of barrels of oil, even on tankers at sea. Both BP and Shell have been active in storing oil on tankers in recent months, according to oil trading sources.

    “The contango has been so steep that, if you have the storage, there is a huge incentive,” said one.

    Volatile prices, round-the-clock trading and the appeal of oil to a broader mix of investors highlight the potential for traders to win or lose millions in minutes.

    Besides trading on futures exchanges, BP and Shell are also active in the over-the-counter markets for physical oil and associated derivatives, which are estimated to be much larger in size than the futures markets.

    ” 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.”

    Yah, we need to get oil producers and oil tankers out of the liquidity fetish game, what public purpose does it serve?

    Reply

  2. warren mosler says:

    and as rising asset prices means falling interest rates savers lose income so even that doesn’t work.

    Reply

  3. Scott Fullwiler says:

    Well said.

    Also, since the only potential effect of QE on aggregate demand comes through rising asset prices . . . that is, capital gain . . . it is surely far more direct to stimulate via deficits sized to get the impact desired on aggregate demand (ELR, for instance) than it is to try and figure out how much bond prices or equity prices or whatever other financial asset prices must rise to provide sufficient capital gains to then raise wealth and thereby stimulate aggregate demand sufficiently. The whole monetarist notion that the central bank can purchase every asset out there until it eventually stimulates the economy as desired seems quite a bit like driving a car while your hands are tied behind your back . . . just untie your hands and it is much easier to get where you are trying to go.

    Reply

Leave a Reply

Your email address will not be published. Required fields are marked *

*

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>