Quantitative easing


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Monetary policy in a period of financial chaos:

The political economy of the Bank of Canada in extraordinary times

Presented at the Political Economy of Central Banking conference,

Toronto, May 2009

Marc Lavoie and Mario Seccareccia

Department of Economics

University of Ottawa

July 2009


“Although quantitative easing is now referred to as an unconventional monetary policy tool, the purchase of government securities is, in fact, the conventional textbook approach to monetary policy…. In practice, most central banks have chosen to conduct monetary policy by targeting the price of liquidity because the relationship between the amount of liquidity provided by the central bank and monetary aggregates on the one hand, and between monetary aggregates and aggregate demand and inflation on the other, are not very stable.” (Bank of Canada, 2009b, p. 26).

The Bank of Canada thus feels compelled to recall that monetary aggregates are very badly correlated with price inflation, and that base money is also very badly correlated with the money supply. To provide excess bank reserves, as recommended by Monetarists, central banks must decline to sterilize its liquidity creating financial operations or it must conduct open market operations by purchasing assets. As pointed out by Deputy Governor John Murray (2009), “All quantitative easing is, by definition, ‘unsterilized’. Although this is correctly viewed as unconventional, it closely resembles the way monetary policy is described in most undergraduate textbooks, and is broadly similar to how it was conducted in the heyday of monetarism”. Murray misleadingly insinuates that such a technique has been implemented before, namely during the 1975-1982 monetarist experiment in Canada. What can really be said is that quantitative easing is an attempt to put in practice what academics have been preaching in their textbooks for decades from their ivory towers. It is merely monetarism but in reverse gear. While monetarist policy of the 1970s was implemented to reduce the rate of inflation, current monetarist quantitative easing is being applied to generate an increase in the rate of inflation.

As a result, the claims of quantitative easing are just as misleading as the claims of monetarism of the 1970s and early 1980s. Bank of Canada officials claim that “The expansion of the amount of settlement balances available to [banks] would encourage them to acquire assets or increase the supply of credit to households and businesses. This would increase the supply of deposits” (Bank of Canada, 2009b, p. 26), adding that quantitative easing injects “additional central bank reserves into the financial system, which deposit-taking institutions can use to generate additional loans” (Murray, 2009). In our opinion, these statements are misleading and indeed completely wrong. They rely on the monetarist causation, endorsed in all neoclassical textbooks, which goes from reserves to credit and monetary aggregates. It implies that banks wait to get reserves before granting new loans. This has been demonstrated to be completely false in the world of no compulsory reserves in which we live since 1994. In any event, even before 1994, as argued by a former official at the Bank of Canada, the task of central banks is precisely to provide the amount of base money that banks require (Clinton, 1991). Banks do not wait for new reserves to grant credit. What they are looking for are creditworthy borrowers.

Quantitative easing is an essentially useless channel. It assumes that credit is supply-constrained. It assumes that banks will grant more loans because they have more settlement balances. Both of these assumptions are likely to be false, at least in Canada. With the possible exception of its impact on the term structure of interest rates, the only effect of quantitative easing might be to lower interest rates on some assets relative to the target overnight rate, as these assets are being purchased by the central bank through its open market operations. It is doubtful that the amplitude of these interest rate changes will have any impact on private borrowing or on the exchange rate. Indeed, in Japan, which has had experience with zero interest rates for many years, quantitative easing was pursued relentlessly between 2001 and 2004, but with no effect, as “the expansion of reserves has not been associated with an expansion of bank lending” (MacLean, 2006, p. 96). Indeed, officials at the Bank of Japan did not themselves believe that quantitative easing could on its own be of any help, but they tried it anyway as a result of the pressure and advice of international experts. As Ito (2004, p. 27) notes in relation to the Bank of Japan, “Given that the interest rate is zero, no policy measures are available to lift the inflation rate to positive territory… The Bank did not have the tools to achieve it”.


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New Deal 2.0


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Excellent!

http://www.newdeal20.org/?p=3388

By Mario Seccareccia
Professor of Economics, Ottawa University
Editor, International Journal of Political Economy

July 23 —
Over the last couple of months, especially as there have been some signs of economic “green shoots,” there have also been growing pressures coming from conservative policy analysts that the Obama administration ought to be planning its “exit strategy,” that is, a plan that would eliminate the deficit over the medium term.

These pressures are based on fears that the large federal deficit, standing at 13.1 percent of GDP, together with the huge reserves that are sitting within the banking system as a result of the Fed’s monetary policy of quantitative easing, will soon metamorphosize into runaway inflation. Just recently, Fed Chairman Ben Bernanke added his voice to the chorus of those who are calling for an exit strategy.

Politically, all of this talk of exit strategy has served to weaken the Obama administration’s capacity to get important legislation passed. For instance, these fears of the deficit bogey have recently prompted the president to commit himself not to sign on to legislation that will add to federal deficits over the longer term.

Such stark commitments will only tie his hands politically and give credibility to a conservative policy view on the negative consequences of deficits that has been completely disproved by the facts. For instance, under the Bush administration, when unemployment rates were much lower than they are presently, we saw a rate of inflation that sat steadily at low levels, despite growing deficits. Moreover, Chairman Bernanke knows fully well that there is no positive relation between the volume of excess reserves in the banking system and credit expansion. The latter is driven by demand from creditworthy borrowers and not by the volume of excess reserves sitting in the banking system. Hence, the real fear should not be inflation but growing unemployment and wage deflation.

All of this talk of exit strategy has served to divert attention from the really important problem of rising unemployment whose official rate may well surpass the double digit threshold soon. Fortunately, there are some connected with the administration who are leery of this talk of exit strategy. For instance, in an article last month, Cristina Romer, chairwomen of the Council of Economic Advisers and scholar of the 1930s Great Depression, recounts how a similar debate over fears of inflation under the FDR administration led to both restrictive monetary and fiscal policies that engineered a second severe slump in 1937-1938 almost a decade after the 1929 crash. Romer cautions that such errors should not be repeated.

It is hoped that clearer heads will prevail in the current administration and that policy will remained focused on combating unemployment. What is needed is not an exit strategy but a full employment strategy. An exit strategy could abort a recovery and could mean that those green shoots will quickly dry up. As Paul Krugman so correctly pointed out in a recent op-ed: “government deficits … are the only thing that has saved us from a second Great Depression.”

Roosevelt Braintruster Mario Seccareccia is editor of the International Journal of Political Economy.


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