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This Is How QE Really Works

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By Edward Harrison

If you want an accurate explanation of quantitative easing, here it is. I am going to describe the basic mechanics and the transmission mechanism to the rest of the economy. To the degree there is official documentation on the mechanics, I will refer to it here in order to use the Fed’s own voice in describing QE. Let’s start with the mechanics.

The Mechanics of QE

In March of 2010, the Fed described QE this way in a paper written by Joseph Gagnon, Matthew Raskin, Julie Remache, and Brian Sack on the New York Fed’s website:

Since December 2008, the Federal Reserve’s traditional policy instrument, the target federal funds rate, has been effectively at its lower bound of zero. In order to further ease the stance of monetary policy as the economic outlook deteriorated, the Federal Reserve purchased substantial quantities of assets with medium and long maturities. In this paper, we explain how these purchases were implemented and discuss the mechanisms through which they can affect the economy.

So quantitative easing is simply large scale asset purchases (LSAP) by the central bank. The central bank is permitted by law to purchase a wide range of assets including but not limited to Treasury securities, mortgage-backed securities, or municipal bonds (see Blanchflower: The Fed Should Buy Munis And Monetize State Debt). Before the first round of quantitative easing, the Federal Reserve’s asset base consisted mostly of Treasury securities. However, as bond market liquidity dried up, the Fed stepped in and purchased a panoply of assets in the first round of quantitative easing including many mortgage-backed securities.

Brian Sack remarked in December 2009:

The Fed is currently in the process of purchasing nearly $1.75 trillion of Treasury, agency, and agency mortgage-backed securities through the LSAP programs. We have already completed our purchases of Treasury securities, totaling $300 billion. And our purchases of agency securities and mortgage-backed securities (MBS) are well advanced. Indeed, we have completed purchases of $155 billion of agency debt securities to date, out of a target level of $175 billion, and of just over $1 trillion of MBS, out of a target level of $1.25 trillion.

The second round of quantitative easing was concentrated on purchases of Treasury securities. While the Fed had about $800 billion in assets in mid-2007, the first round of QE swelled this to $2.25 trillion by December 2009. The Fed’s asset base is now moving toward $3 trillion.

In the March 2010 paper, the NY Fed goes on to say:

We present evidence that the purchases led to economically meaningful and long-lasting reductions in longer-term interest rates on a range of securities, including securities that were not included in the purchase programs. These reductions in interest rates primarily reflect lower risk premiums, including term premiums, rather than lower expectations of future short-term interest rates.

But this is a subjective conclusion. The purpose of the paper is to provide the intellectual underpinnings to defend the Fed’s large scale asset purchases. Therefore, one should view the mechanics presented as objective and the conclusions as subjective. For example, In Sack’s December 2009 speech, he said:

The LSAPs were not aimed at supplying liquidity to financial institutions or at reducing systemic risk. Instead, they were intended to support economic activity by keeping longer-term private interest rates lower than they would otherwise be.

A primary channel through which this effect takes place is by narrowing the risk premiums on the assets being purchased. By purchasing a particular asset, the Fed reduces the amount of the security that the private sector holds, displacing some investors and reducing the holdings of others. In order for investors to be willing to make those adjustments, the expected return on the security has to fall. Put differently, the purchases bid up the price of the asset and hence lower its yield. These effects would be expected to spill over into other assets that are similar in nature, to the extent that investors are willing to substitute between the assets. These patterns describe what researchers often refer to as the portfolio balance channel. [EMPHASIS ADDED]

Sack is telling us that the Fed did not intend to perform a lender of last resort role, a legitimate Fed function. Rather, the Fed’s intention was to artificially supress risk premia to support economic activity. This is important to remember.

The money used to purchase these assets is created specifically for the transactions. That is to say the money did not previously exist before the transactions. This fact is what is behind the view that the Fed is ‘printing money’, a term Ben Bernanke, the Fed Chair also used when describing QE in 2009 (see Jon Stewart: The Big Bank Theory).

The Fed uses permanent open market operations (POMO) to conduct its large scale asset purchases. The Fed explains POMO this way:

The purchase or sale of Treasury securities on an outright basis adds or drains reserves available in the banking system. Such transactions are arranged on a routine basis to offset other changes in the Federal Reserve’s balance sheet in conjunction with efforts to maintain conditions in the market for reserves consistent with the federal funds target rate set by the Federal Open Market Committee (FOMC).

On March 18, 2009, the FOMC announced a longer-dated Treasury purchase program with a different operating goal, to help improve conditions in private credit markets.

On August 10, 2010, the FOMC directed the Open Market Trading Desk at the Federal Reserve Bank of New York to keep constant the Federal Reserve’s holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities.

On November 3, 2010, the FOMC decided to expand the Federal Reserve’s holdings of securities in the SOMA to promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.

Note, August 2010 was when the Fed started QE2. November 2010 was when QE2 was first announced as the Fed decided to expand its balance sheet.

That’s the mechanics.

Transmission Mechanism

How QE actually works is the more subjective part of quantitative easing. Brian Sack told us in 2009 that the Fed was not performing its role as lender of last resort but rather it was ‘manipulating’ risk premia in order to lower long term interest rates to boost the real economy. I use the term ‘manipulate’ rather deliberately as I believe QE introduces a distortion into the markets by making price signals difficult to read for investors and businesses alike. The Fed is attempting to lower interest rates artificially. By that, I mean it is not saying that risk premia are elevated because of liquidity since Mr. Sack has already told us it is not performing a lender of last resort role. The Fed is trying to supress risk premia dictated by market forces through its own activity.

Now, in fairness to the Fed, this is exactly what it does with short-term interest rates by setting the Fed Funds rate. However, with short-term rates at zero percent and the economy still not firing on all cylinders, the Fed is telling us short-term rates at zero percent is not enough stimulus. It wants long-term interest rates to be lower than the market-determined rate as well. Clearly, this is a massive attempt at central planning and is, thus, likely to have unintended consequences like excess leverage and speculation.

You can read Ben Bernanke’s views on the QE2 transmission mechanism in my post "The government has a printing press to produce U.S. dollars at essentially no cost". I take a benign approach to Bernanke’s comments there. However, Marshall is less flattering in "Amateur Hour at the Federal Reserve". But, go back to QE1 and read Marshall’s piece "Bernanke doesn’t understand the basic economics of central banking" from December 2009. I think this got to the heart of the matter when Marshall told us loans create reserves and warned that QE would have nearly no impact on lending – which proved true.

The loan desk of commercial banks have no interaction with the reserve operations of the monetary system as part of their daily tasks. They just take applications from credit worthy customers who seek loans and assess them accordingly and then approve or reject the loans. In approving a loan they instantly create a deposit (a zero net financial asset transaction).

Bernanke often speaks as if he believes reserves create loans. I prefer Janet Yellen, the Fed Vice Chair, and the way she recently explained how QE is transmitted to the real economy. She writes:

Some General Observations

It is important to recognize at the outset that conventional and unconventional monetary policy actions bear many similarities. Forward guidance concerning the path of the federal funds rate, for example, is explicitly intended to influence market expectations concerning the future trajectory of shorter-term interest rates and thereby affect longer-term interest rates. That said, standard monetary policy actions also typically alter not just current short-term rates, but the anticipated path of short-term rates as well, influencing longer-term rates through the identical channel. In fact, central bankers have long recognized that this “expectations channel” operates most effectively when the public understands how policymakers expect economic conditions and monetary policy to evolve over time, and how the central bank would respond to any changes in the outlook.

The transmission channels through which longer-term securities purchases and conventional monetary policy affect economic conditions are also quite similar, though not identical. In particular, central bank purchases of longer-term securities work through a portfolio balance channel to depress term premiums and longer-term interest rates. The theoretical rationale for the view that longer-term yields should be directly linked to the outstanding quantity of longer-term assets in the hands of the public dates back at least to the 1950s.(2)

Each of these policy tools tends to generate spillovers to other financial markets, such as boosting stock prices and putting moderate downward pressure on the foreign exchange value of the dollar. My reading of the evidence, which I will briefly review, is that both unconventional policy tools–the use of forward guidance and the purchases of longer-term securities–have proven effective in easing financial conditions and hence have helped mitigate the constraint associated with the zero lower bound on the federal funds rate.

-Unconventional Monetary Policy and Central Bank Communications

What she is discussing is something called the expectations theory of interest rates.

It works like this:

long-term interest rates can be expressed as a series of short-term interest rates, such that if you know long-term rates, you can calculate expected future short-term interest rates. This is important because it tells you what people believe the Federal Reserve is likely to do with interest rates in the future.

-MMT: Market discipline for fiscal imprudence and the term structure of interest rates

The Fed telegraphs how short-term rates will or will not be affected by the real economy and expectations shift accordingly. Therefore, to the degree the Fed is successful in getting long-term interest rates to move, it is because it has adjusted those expectations. That’s how it works.

The reason this is true is market arbitrage. Any market participant could go out into the market and purchases zero coupon treasury strips as an arbitrage against long-term Treasury yield mispricing if long-term rates did not reflect the path of future expected short rates. Let me repeat that: if long-term rates don’t reflect the expected path of short-term rates, you have a sure fire arbitrage opportunity. If the Fed is destined to keep rates at zero percent for the next five years and I am sure of it, but the yield on five-year Treasuries don’t reflect this, all I have to do to make money is buy the five-year and sell Treasury strips and leverage that trade up in the Repo market. Isn’t that what some investment banks are doing right now – ploughing their POMO acquired money into a leveraged bet on Treasuries? That is exactly what happened after the first jobless recovery in 1992-1994 before Greenspan caused a huge bear market in Treasuries by raising rates.

Look, quantitative easing is an asset swap. The Fed creates electronic credits and swaps them with existing financial assets. If the Fed is buying government paper, it is essentially trading one government liability for another, swapping a demand deposit electronic credit for a longer-dated government liability.

From the government’s perspective, there is no functional difference between any of its obligations like bank notes, electronic credits, or treasury bills and bonds. As the Ten pound note says, “I promise to pay the bearer on demand the sum of [fill in the blank sum][fill in the blank fiat currency].

-If the U.S. stopped issuing treasuries, would it go broke?

So QE2 Is Equivalent to Issuing Treasury Bills. In actual fact, all QE2 does is drain the real economy of interest income by swapping an interest-bearing government liability for a non-interest bearing government liability. This decreases aggregate demand in the economy. So the real economy effects of QE are to slightly lower aggregate demand. This is offset by changing interest rate expectations, which alter private portfolio preferences and risk premia, leading to credit growth, leverage and speculation, forces which should pump up the real economy. The Fed had intended to lower interest rates via the lowered risk premia. To date, the Fed has lowered risk premia. But this has also provided the tender for speculation and leverage. Moreover, the Fed has also raised inflation expectations to boot, causing interest rates to rise and working at cross-purposes with the lowered risk premia. Thus, QE2 has only been successful insofar as it has increased business credit and raised asset prices. In my view, QE2 has been a bust as it adds volatility to the system and will have negative unintended consequences down the line.

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About Edward Harrison

I am a banking and finance specialist at the economic consultancy Global Macro Advisors. Previously, I worked at Deutsche Bank, Bain, the Corporate Executive Board and Yahoo. I have a BA in Economics from Dartmouth College and an MBA in Finance from Columbia University. As to ideology, I would call myself a libertarian realist - believer in the primacy of markets over a statist approach. However, I am no ideologue who believes that markets can solve all problems. Having lived in a lot of different places, I tend to take a global approach to economics and politics. I started my career as a diplomat in the foreign service and speak German, Dutch, Swedish, Spanish and French as well as English and can read a number of other European languages. I enjoy a good debate on these issues and I hope you enjoy my blogs. Please do sign up for the Email and RSS feeds on my blog pages. Cheers. Edward

67 comments

  1. olddeadmeat

    Going to have to read this thru about 4 more times to wrap my head around it, but thanks for covering it.

  2. dave

    So you reduce demand created by cash (people spending money they receive from the government in interest payments on their savings) in the hopes that lower rates get banks to create more demand by issuing credit.

    Because, you know, interest bearing credit is so much better then non interest bearing cash.

  3. Scott Schaefer

    Question: Under what authority may the Fed purchase munis with maturity dates greater than six months in the future ??

    You even noted in the Blanchflower posting: “Did you catch that. The Fed can legally buy as many municipal bonds as it wants without congressional approval. Talk about burying a lead.”

    Yet, you did not choose to elaborate. I am reasonably certain these are NOT guaranteed via federal “full faith and credit” (unlike GSE MBS since 12/24 ‘surprise’ legislation). Which means there must have been recent legislation amending Reserve Act to allow PURCHASING munis, as opposed to discount lending to member banks pledging munis as collateral.

    1. Edward Harrison Post author

      Scott, the quote from Blanchflower is exactly as you read it “They are limited to only federally insured paper, which includes Treasuries and mortgage-backed securities insured by Fannie Mae and Freddie Mac. But they are also allowed to buy short-term municipal bonds”.

      As you indicated, I suppose the Fed could also lend against municipal bonds as collateral in a liquidity crisis. This is how they obtained a lot of mortgage assets during the crisis. Depending on the length of the commitment, these loans could also effectively be a purchase.

      1. Scott Schaefer

        Correct — the quote from Mr Blanchflower does contain the words “short-term”. Which, unless someone tells me differently, I assume means “maturity date of six months or less”.

        Which begs the question: Just how many and what $$ amount of municipals are actually legally eligible for Fed purchase ?? I think it is likely < 150B, and is thus not "as many as (the Fed) wants", even before considering costs of making this # of relatively) small purchases via buying $10B in Treasuries from the PDs daily.

  4. Fed Gaming

    Another element I believe…

    The FED, by lowering interest rates, allows the Federal government to expand its fiscal deficit thwarting the attempts of the market (via interest rates) to reign in these excesses.

    This expansion in Federal debt serves as a credit expansion (inflationary) and serves to decrease the full impact of the debt deflation from the private market. However, eventually the private market will scream NO MORE on interest rates and the FED will either have to break the law more explicitly or the ponzi scheme will fail. Shortly before this moment, the FED will recognize fully the error of their strategy.

  5. Edward Harrison Post author

    Also, I don’t want to gloss over the risk premia discussion but clearly Yellen and Sack are saying they are trying to change private portfolio preferences independent of future rate rises. Meaning that the risk premia, for holding long-dated paper is suppressed. And analogously, I assume the risk premium for holding risk assets is suppressed. This is a manipulation of price signals and will create a misallocation of resources.

    1. Attitude_Check

      Edward,

      It sounded like a direct admission to intentionally cause the mis-pricing of risk! That would be completely outside the FED charter and a VERY bad idea. It was the mis-pricing of risk that resulted in the credit bubble that “popped” in 2008. So of course the correct response is to intentionally force risk mis-pricing again?

      Since I don’t think he is as stupid as his comment sounds, that implies a complete disregard for the rule of law, free market capitalism, and the American public. At what point does this become Treason?

      1. beowulf

        “Since I don’t think he is as stupid as his comment sounds, that implies a complete disregard for the rule of law, free market capitalism, and the American public. At what point does this become Treason?”

        Treason against the United States, shall consist only in levying War against them, or in adhering to their Enemies, giving them Aid and Comfort.

        Umm, short of the Fed creating a special Credit Facility to bankroll Al Qaida, never. Before the Board of Governors followed Benedict Arnold too far down the path of treachery and sedition, they’d trigger a termination of their appointments when they’re “removed for cause by the President” per the FRA. Indeed if the BOG acted in violation of the “rule of law” un any way, the President could fire them.

        That he hasn’t means either the conspiracy runs much deeper… or that you’re wrong and the Fed is acting lawfully (and patriotically). Sure they don’t understand the basics of Modern Monetary Theory, but if that were a crime, neither House of Congress could make a quorum.

        Good piece Edward.

  6. Hugh

    I think in QE1 there was a net transfer because banks could unload MBS and other securities on to the Fed if they had a high enough rating at full value when there realy value was probably 40%-60% less. The banks came out winners on this directly but also indirectly since it helped support the valuations of the rest of the assets on their balance sheets. Briefly, they could unload illiquid dreck at full price and pretend that the rest of the dreck was also worth full price. But as we said at the time and as events showed, this did not loosen up lending. Banks could make more making bets and blowing bubbles in the casino of the markets. At the same time, potential borrowers had dried up because they were either paying down debt or trying to keep from being overwhelmed by it.

    I agree the effect of QE2 buying Treasuries actually reduces liquidity/money available in the economy marginally due to the loss of interest income. Of course, some of this is recaptured by banks frontrunning the Fed and bidding prices up on Treasuries.

    Personally, I think QE2 was more a psychological signal to the banks that the Fed favored the casino staying open. And it’s not like they still can’t borrow short term at 0% anyway.

    Finally, “reducing risk premia”??? Didn’t this used to be called promoting moral hazard?

      1. yoganmahew

        I agree with you @Hugh and think that supporting asset prices at a time when there was danger of a dump of agency paper is a far more serious charge than of buying assets to cap interest rates.

        The Fed has always attempted to influence interest rates. Before Volcker it was long-term rates that were targeted; with Volcker, the focus changed to the short. With Bernanke, it has changed again to targeting the entire curve – sometimes by buying all along it, sometimes by buying portions of it.

        If suppressing interest rates had been the only goal of QE, then no action need have been taken. The economy and more particularly the financial system would have slowly zombified, deflation would have become persistent and a shiny japanning would have resulted in low long-term rates.

        Preventing firesale prices is a ‘neat’ way of supporting liquidity because it sets a shelf in the price of assets. If there is always a willing buyer at a certain price-point, it is possible to create a scarcity and modern financial theory appears to work on the basis of the scarcity value of assets, not on their income value (price is more important than revenue).

        I say ‘neat’ above, actually, I could substitute totally rubbish. It is a prolongation of a level of debt that is unsustainable. By attempting to keep value in one side of the financial system (the banks and the bank shareholders), an effort is being made to cover up the holes in the rest of the financial system – household balance sheets and corporate balance sheets (those corporates that are not cash rich are more indebted than they have ever been). It is a finger in the hole in the reactor housing… eventually the finger will melt and the debt-deflation bomb will explode.

        There’ll be no need to worry about long-term yields then…

        1. Masa Crítica Caballeros


          totally rubbish. It is a prolongation of a level of debt that is unsustainable. By attempting to keep value in one side of the financial system (the banks and the bank shareholders), an effort is being made to cover up the holes in the rest of the financial system – household balance sheets and corporate balance sheets (those corporates that are not cash rich are more indebted than they have ever been). It is a finger in the hole in the reactor housing… eventually the finger will melt and the debt-deflation bomb will explode.

          ~~yoganmahew~

          Fed governors have hidden the true risk premium by narrowing the apparent risk premiums on the assets thus propping up asset pricing, thus fraud. We got trouble in River City. We got Trouble with a capital T. We got’s to snag us some jail-birds before this turns into a case of trickle-down-fraud. Mount up, Posse Comitatus! Mount up, load up, and ride out.
          !

  7. Tao Jonesing

    ” In actual fact, all QE2 does is drain the real economy of interest income by swapping an interest-bearing government liability for a non-interest bearing government liability. This decreases aggregate demand in the economy. So the real economy effects of QE are to slightly lower aggregate demand.”

    First, is interest income counted as part of GDP, the common measure of aggregate demand? I know that interest paid to service existing debt is not couted in calculating PCE, and usually the BEA balances everything out accounting-style. (This is the basis for the imputations of income for food received at the workplace, etc.; the expense incurred by the business is imputed as income to the workforce and used to calculate savings rate, etc.)

    Second, whether or not QE actually lowers aggregate demand, to the extent it distorts the prices of staple consumer commodities, it necessarily shifts how aggregate demand is allocated away from discretionary items, which can and likely will lead to unemployment.

    Regardless, QE clearly was not designed to promote price stability and ensure maximum employment. It’s just a crutch for the FIRE sector.

  8. John Merryman

    Edward,
    Would there be a possibility of looking at the historical application of the opposing function? Specifically how Paul Volcker cured inflation by raising interest rates.

    It has long been my contention that the increase in Federal deficits were the actual mechanism for bringing inflation under control, not the actions of the Federal Reserve.

    Inflation is a consequence of excess capital relative to demand, but raising rates only rewards those with the surplus, while punishing the demand side of the equation, with higher borrowing costs. On the other hand, increased deficit spending has the same effect of drawing down surplus capital, but rather than taking it out of circulation, with just the additional cost of paying interest to those with a surplus of capital, the money the Treasury borrows is spent back into the economy in ways which encourage further private sector investment, thus having a multiplier effect on the demand for capital.

    The issue goes to the heart of how monetary systems work, versus the expectations we desire. Capital is subject to the laws of supply and demand, so that ultimately it is demand which limits how much wealth the economy can support and creating surplus supply requires the manufacture of synthetic demand, which is what all these bubbles are about.

    The problem is that by the Fed’s own logic of selling debt to draw out excess capital, the surplus is in the hands of those with a surplus, which is not a politically convenient fact for the wealthy and powerful. Simply borrowing it from those reservoirs of wealth, be they individuals, or any other entity holding large concentrations of capital, in order to spend it to maintain the integrity of the larger economy, from which all wealth is derived, only creates larger problems down the road, as wealth is drained out of the larger economy to pay the interest. The result being large storm clouds of surplus wealth, hovering over an increasingly parched economy, ultimately doing no one any good, when the entire structure collapses.

    If we are ever to resolve these issue, we will have to start treating money as the contract it is, not the commodity we wish it to be. As a medium of exchange, it is the foundation of the market, not just one factor in it and when private parties control that function, they control the entire market.

    Either we go back to multiple private and semi-private currencies, or develop a system of public banking, in which local public banks cycle wealth through local communities, with both sides of the contract, supply and demand, given equal weight and use the income to service the local infrastructure, with larger regional and national functions built on this foundation. Rather than having large national banking companies drain value out of communities.

    1. Some Jerk

      Inflation is a consequence of excess capital relative to demand, but raising rates only rewards those with the surplus, while punishing the demand side of the equation, with higher borrowing costs. On the other hand, increased deficit spending has the same effect of drawing down surplus capital, but rather than taking it out of circulation, with just the additional cost of paying interest to those with a surplus of capital, the money the Treasury borrows is spent back into the economy in ways which encourage further private sector investment, thus having a multiplier effect on the demand for capital.

      What you’ve just said is one of the most insanely idiotic things I have ever heard. At no point in your rambling, incoherent response were you even close to anything that could be considered a rational thought. Everyone in this room is now dumber for having listened to it. I award you no points, and may God have mercy on your soul.

  9. moslof

    If Madoff had access to these “tools” (methods of moving “assets” from one pocket to the other) he would still be in business. I read recently that the only significant growth in credit that has been achieved by these policies is in the student loan sector. Good luck with that.

  10. Bev

    I found the following explanation very helpful. The conclusion is that much like the good approach for citizen’s benefits by the No Debt Money circulated via the Public Bank, The Bank of North Dakota, is this similar approach at the level of the Federal Government, that is also using NO DEBT Money (of course, toward what goals to be accomplished is very important):

    from: Ellen Brown, Web of Debt

    from: 
http://webofdebt.wordpress.com/?page_id=939&preview=truehttp://


    The Federal Reserve is finally using its “quantitative easing” (QE) tool to good purpose, and I’m endorsing that, not just for our central bank but for any central bank anywhere that would be so bold. We are trapped in a web of debt devised by an international banking cartel that has hoodwinked us into believing that we have no recourse but to use money created by their banks as loans. We do have recourse. Money today is simply a legal agreement, an acknowledgment of services performed and debt owed.

    Every country can and should issue its own money and its own national credit. This would NOT inflate prices, for reasons I have explained again and again.

    If “money” originates as a receipt for goods and services delivered to the government — rather than in speculative leveraging by banks not attached to real productivity — supply and demand will increase together, and prices will remain stable.

    If the money supply increases beyond GDP, the excess can be taxed or otherwise drawn back to the government. 
…Chapter 40, which is all about Ben Bernanke’s helicopter money, says in part (again this was first published in 2007):
“[I]n a speech he delivered when he had to be less cautious about his utterances, Dr. Bernanke advocated what appeared to be a modern-day version of Lincoln’s Greenback solution: instead of filling the balloon with more debt, it could be filled with money issued debt-free by the government. 


    “The speech was made in Washington in 2002 and was titled ‘Deflation: Making Sure ‘It’ Doesn’t Happen Here.’ Dr. Bernanke stated that the Fed would not be ‘out of ammunition’ to counteract deflation just because the federal funds rate had fallen to 0 percent. Lowering interest rates was not the only way to get new money into the economy. He said, ‘the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. 


    “He added, ‘One important concern in practice is that calibrating the economic effects of nonstandard means of injecting money may be difficult, given our relative lack of experience with such policies.’ If the government was inexperienced with the policies, they were not the usual ‘open market operations,’ in which the government prints bonds, the Fed prints dollars, and they swap stacks, leaving the government in debt for money created by the Fed.

    Dr. Bernanke said that the government could print money, and that it could do this at essentially no cost. The implication was that the government could create money without paying interest, and without having to pay it back to the Fed or the banks. 


    snip

    
QE2 is not quite replacing taxes with money printed up by the government, but as I wrote in the article criticized by Mr. North, in our current system it is the functional equivalent and the next best thing. The Fed is funding the federal deficit by buying long-term government bonds with money created with a computer keystroke, and the Fed rebates its profits to the government after deducting its costs, so this funding is nearly interest-free.

    These bonds never have to be paid back, because the federal debt is never paid back. An interest-free debt rolled over indefinitely is the functional equivalent of debt-free, government-issued money. 


    snip


    Virtually all money today originates as debt, and private debts eventually get repaid, so somebody has to be in “permanent” debt to maintain a stable money supply.

    The federal debt serves this role. The federal debt has been the basis of the U.S. money supply ever since the Civil War, when the National Banking Act authorized private banks to issue their own banknotes backed by government bonds deposited with the U.S. Treasury.

    
snip


    Economist John Kenneth Galbraith wrote in 1975: 
“In numerous years following the [civil] war, the Federal Government ran a heavy surplus. [But] it could not pay off its debt, retire its securities, because to do so meant there would be no bonds to back the national bank notes. To pay off the debt was to destroy the money supply.”


    snip

    
Indeed, that is the secret to adding “money” to the system without inflating prices: it needs to be used for productive rather than speculative purposes. Inflation results when “demand” (money) exceeds “supply” (goods and services). When money is used to “make money” (speculation) without adding to goods and services, prices are driven up. When the money is used to produce goods and services, supply and demand increase together and prices remain stable.


    The issue posed by QE2 is the sovereign right of a country to print its own money, debt-free and interest-free. Whether conservative, liberal, or populist, any true patriot would support that; and we should support it not just for the United States but for all countries. 


    snip


    Gold won’t work and the 100% reserve solution won’t work; in fact they’re very close to the same thing. The Euro system is in the nature of a gold/100% reserve/fixed currency solution, and it has just proved that those won’t work. A public credit system will work, and there are already finer minds than mine working on the details, globally.

  11. Chris of Stumptown

    “In actual fact, all QE2 does is drain the real economy of interest income by swapping an interest-bearing government liability for a non-interest bearing government liability. This decreases aggregate demand in the economy.”

    I don’t think I agree with this.

    Govt funds via Treasury debt. The private sector saves via funding govt debt.

    If the Fed creates new money to fund purchases of Treasury debt, the private sector does not save. The govt gets spending power without using spending power of the private sector.

    This is expansionary.

    1. Edward Harrison Post author

      Chris that’s the only real economy effect of QE – a loss in interest income. The MMT’ers all mention this as well when talking about QE.

      The Fed hopes that minor effect is offset by the hopefully much larger affect on risk premia and interest rates. But we’re talking about expectations in the financial channel here not direct effects on the real economy.

      1. Chris of Stumptown

        This still doesn’t seem right to me. Say I loan the govt $1 to buy a box of pencils. That’s a dollar I no longer have, so I cannot buy pencils. But if the Fed creates $1, and loans it to the govt, then the govt and I each buy pencils. The Fed has changed demand for pencils from 1 to 2 boxes. I would characterize this as a real economy effect. Surely you agree, right?

        I think Bullard had it right, that Fed purchases of bonds would be viewed as inflationary because it is inflationary.

        Maybe expectations are larger than the real economy effect, but it seems way to glib to say that there is no real economy effect. That’s quite a stretch.

        1. Karen

          I see it the same way, Chris. Money is a commodity that cannot defy the law of supply and demand.

          People have understood that for centuries, but the Industrial Revolution made the gold standard obsolete and unfair (when real wealth increases quickly but the money supply stays essentially constant, then rich people can get a lot richer simply by sitting on their stashes without even lending the money out) so we are stuck with the lesser (?) of evils, fiat currency – and the need to control our leaders’ impulse to abuse the power to issue money.

          It often takes a while for the economy to adjust, especially if people are not used to dealing with this situation, as we aren’t in the USA. I’d bet Argentina’s economy adjusts much more quickly whenever their government engages in QE! But just because we don’t see inflation right away after QE, doesn’t mean the QE isn’t inflationary.

      2. MyLessThanPrimeBeef

        The economy’s loss of interest income = less interest expense for the government…the difference it can use to build bridges to nowhere that hopefully are able to withstand a great earthquake.

        If not, more can be built and rebuilt, stimulating the economy further.

        In this way, the aggregate demand is decreased and increased.

    2. Tao Jonesing

      “This is expansionary.”

      QE money is not funded by creating Treasury debt. QE money is, to use a trite and overused phrase, “created out of thin air.”

      When money “created out of thin air” is used to extinguish existing debt (i.e., through the purchase of an existing bond instrument), that money is not expansionary. It’s a nullity.

      Mr. Harrison is right. I just don’t know if I agree that taking the future interest income out of the equation results in any official effect on GDP. Also, the pricing of the security purchased by the Fed as part of QE should reflect the NPV of that interest, so, while the long term effect is to eliminate future interest income, the near term effect is to provide the seller with the NPV equivalent of that interest income. They wouldn’t sell if thought they could get more value by holding the security and getting the interest income.

      1. Attitude_Check

        I don’t think you are right here.

        Imagine a simple economy with 100 units of money. Joe lends Carol 1 unit, so the Total is 100+1-1 = 100 or no net change. Then Ben “creates” QE of 1 credit and pays Joe off, because Carol can’t. Total money is now 100+1+(-1+1) = 101.

        1. ScottS

          You’re saying that Carol still owes Joe $1 after Joe has been repaid by Ben? You must work for a bank!

          Kidding.

          So if Carol’s debt is wiped out, then Tao Jonesing is correct that you’re back where you started, minus the expected interest on the loan to Carol, and Joe is forced to go searching for another good credit risk that wants to borrow money.

          Consider also that the $1 didn’t actually exist until Joe and Carol signed the paperwork originally loaning her the money. Consider also that the reserves to back up the loan didn’t exist until the loan was created.

          Then you understand that banks simply are a broker between the central bank and the customer, and live on the spread between the prime interest rate and the interest rate to the customer. The money supply is never fixed, simply expanding and contracting in response to demand.

          Now it makes sense why banks think they should have not be required to hold capital reserves, since it’s not necessary 99% of the time. It’s during crises that they need it, not during the origination.

  12. Edward Harrison Post author

    Thi is a quick comment because I am getting ready for a media spot (on RT America – I think it’s on at 530ish?).

    Anyway, I didn’t want to muddy the waters above but I think the talk of risk premiums by Sack and Yellen is a moral hazard as Hugh says.

    What I find odd is how Brian Sack is at pains to point out that QE1 was NOT done on the grounds of providing liquidity. He says “The LSAPs were not aimed at supplying liquidity to financial institutions or at reducing systemic risk”. Instead he says QE is all about altering the price signal, that is what risk really is – a price signal. I would call this an artificial suppression of price signals – and see it as a bad thing.

    But here’s my problem:

    1. Sack says QE1 is not about liquidity but risk premia.
    2. Later, the Fed says the panic is over.
    3. But, then it turns to buying up Treasuries instead of MBS.

    So why did the Fed stop buying MBS? Was it for political reasons? I assume Sack would say that he felt the risk premia for those specific assets were lowered enough by the Fed, that the Fed was successful so they moved on to trying to stimulate the economy as a whole via Treasuries.

    I don’t buy it. It is all very dodgy and I am afraid of the unintended consequences.

  13. gary

    I hope I understand this correctly. It seems to me that the most important feature of this activity is that extra money supply is introduced at specific points to create short term distortions which are intended ultimately to boost economic activity. As the extra money moves around the economy it may be removed from the system, or the concomitant inflation used to reduce the real value of the debt. Is that about it?

  14. pater tenebrarum

    ‘look, it’s just an asset swap’….yeah, completely harmless.Leaving aside for a moment that nobody should try to fix prices, even the ‘price’ of money, the ‘asset’ the Federal Reserve swaps for treasury bonds is commonly known as MONEY, the general medium of exchange, which it creates from thin air, i.e. it prints money. This is inflation, pure and simple. It is decidedly NOT the ‘equivalent of issuing t-bills’.
    QE explained here in more common sense terms:
    http://www.acting-man.com/?p=5546

  15. James

    You state “Each of these policy tools tends to generate spillovers to other financial markets, such as boosting stock prices “

    Can you clarify succinctly what the precise transmission mechanism to pump up stocks is?

    Is it that lowering interest rates on the longer dated maturities diverts new money into stocks?

  16. scraping_by

    The notion of using third order effects to support a failing economy (ours) may be the best way to go for legal, historical, political, gaming, social and artistic reasons, but it’s like a lot of faith-based policy; it’s better in discussion than on the ground.

    Looking at the first order, it’s the Fed printing up a lot of money and handing it over to banks, hedge funds, and a lot of other well-connected sorts. The fiction is that they’re making stupid deals for worthless assets. Unless there’s an ironclad agreement the wallpaper be bought back at par, this is just handing over money to people with money.

    The second order, that this will depress long-term interest rates, is at best hit and miss. The interest rate is either a risk premium, which has little to do with the amount and mostly to do with whose money is at risk; or it’s a bid for business which, given the anemic demand outside the secondary markets, is overpriced at nil. In any case, there’s leakage in the supply (the Chinese buy gold, everyone speculates in wheat and oil, it’s sucked out of the balance sheet in bonuses, etc.) and the numbers to cover are open-ended. Perhaps infinite.

    The third order, that lowering long term interest rates may entice people in the real economy to borrow for economic activity, is also tenuous. Many citizens are free from absurd mortgage payment, and except for those who get mugged by the health industry, are not yet in debt peonage that’s the new bankruptcy. But the percentage of non-workers in the economy is growing, and any hope business has for them being retirees with million dollar nest eggs is more smoke and mirrors. Even Wal-Mart may be figuring out they’ve exported the wages of its customers, and may have to try to get by selling groceries to people on relief. The huge cash reserves at operating companies reflects the realization that almost any investment predicated on middle-class incomes is going to limp along, at best. And of course, the ones going under shouldn’t receive loans at all.

    All in all, papers and pronouncements aside, the Fed is looking after Wall Street and letting Main Street go hang. Printing money to do dumb deals isn’t much of an economic model. Trickle down economics is many things, but it’s not a workable policy.

  17. Anonymous Comment

    Thanks for this great breakdown of the QE’s Ed Harrison. I am really appreciating it and I’m about halfway through. I don’t want to distract my further reading with this though [which I think is important.]

    Re: “Note, August 2010 was when the Fed started QE2. November 2010 was when QE2 was first announced as the Fed decided to expand its balance sheet.”

    If you read it again you will notice you are giving the impression it was begun before it was announced. I think what you are meaning to convey is that in August the chairman signaled, tragically, that he was open to more QE and that since the market reacted to that as great news, the effects of QE2 were felt buy a market that wanted to lock in the chairman to that course of action, before the action took place.

    I think that is the extended version to your nutshell. If I have it right.

    1. Jackrabbit

      Ed,

      The reinvestment of QE1 funds, which began in Summer 2010 is often termed QE 1.5, while the use of new money (new commitment of funds/”printing”), which began in early November 2010, is referred to as QE2.

      1. Anonymous Comment

        That’s how I have generally thought of it as well. Although it was impossible for ‘fed watchers’ to miss the uptick that began with the announcement of QE2 considerations, what I think you are calling QE 1.5.

        The way it felt to me was that Aug did begin the FIRM expectation of liquidity. [Contradiction? - nah, the new normal.] The moment I heard/read it… I was like, oh noes, here comes the end of the empire.

        Once the expectations became so firm, the chairman would have been the ultimate mix-messager not to follow thorough on his word. By Novemeber, it HAD TO happen, and so did everything that followed. Expectations are a bitch.

        How important expectations are: I will not associate with people who will not agree that: Reality is more important than expectations. Even still, they’ll get ya every time.

        Thanks again.

        1. Further Comment

          What I meant to include is that for phrasing… what it felt like to me was announcement in August was ‘QE2′ because expectation-behavior proceeds fed-action aka front running… The announcement was effectively the beginning of QE2, while the application/fulfillment was kinda QE2.1. Not sure, just felt that way. As if the market had gotten ahead of itself.

          I felt it earlier, but I didn’t mention it because I didn’t want to get ahead of myself. [I have that tendency.]

  18. Frank T,

    It would take new legislation, but I have a house I’d like to sell the Fed for its nominal value (my purchase price) rather than its present market value. I would be happy to take that money and re-allocate it to stimulate the economy. Call it QE3.

  19. billwilson

    How much does the fact that the US dollar is the major reserve currency play into this? It has looked to me like many of the fiscal and monetary impacts have been muted by leakage through international markets (as opposed to being contained within the domestic economy).

    In fiscal policy for example, stimulus often finds its way indirectly to say China (as an unemployed person spends his unemployment benefits on imported cheap Chinese goods, therefore stimulating the Chinese economy, not the US economy as intended).

    In monetary policy, if the FED is buying up all the Treasuries being issued (which effectively it is under QE2) where do the trade surplus countries put their “surpluses”, if not in Treasuries? – and figures seem to show they are not going into Treasuries. These surpluses have to be being recycled somehow.

  20. Jackrabbit

    Ed says: Its all very dodgy.

    I’m not a Fed expert by any means, but I am a skeptic that has been wondering if the Fed’s talk of lowering interest rates has just been a canard.

    Before QE2 was announced there was talk about the Fed acting to change Bank’s desire to hold Reserves/Treasuries (“free money”) but upon announcing QE2 the Fed choose to highlight possible beneficial effects of a lowering of interest rates over influencing Bank’s to lend. The Fed doesn’t want to admit to yet another backdoor bailout so they have painted QE2 as beneficial to the economy.

    The Fed could influence bank behavior and the economy by either lowering long term T-rates – reducing the incentive to hold Treasuries – or by artificially raising them so that banks effectively get a higher “real margin” (for lack of a better term) when making a loan. (Remember, the rise in rates is illusionary – a creation of the Fed – until the market adjusts).

    Comparing the two approaches leads to a clear choice. Buying enough Treasuries to LOWER rates would almost certainly mean printing so much that inflation expectations increase, causing the Fed to pay an ever higher market premium for each purchase in order to keep rates down. A sustained buying program that aimed to lower rates would also be a give-away to ALL holders of Treasury debt so it is very inefficient.

    So while the Fed talks about helping the economy by LOWERing interest rates it seems to me that they probably knew that large scale purchases of longer-term Treasuries was likely to have the opposite effect. But that’s still a policy win (from their perspective). In fact, rates actually declined a bit after QE2 was announced (in anticipation of QE2 purchases) but shot up – at a historic rate! – after Nov. 3 when QE2 began. QE2 may have been a boondoggle for the Banks if they played these Fed-induced false expectations correctly. (I call this possibility “the 2nd Great Short”).

    Is QE2 working?

    * If they hoped to reduce rates, that goal seems to have failed. (Now they say that rates are lower than what they otherwise would be!)

    * If they hoped to increase loans, the jury is still out as described in today’s bloomberg:Bernanke Recovery Flawed as Companies Get Credit Denied to U.S. Consumers:

    For small businesses, loan officers easing outnumbered those tightening by 1.9 percentage points after 7.1 points in the previous period. The banks were still toughening their criteria for small businesses and consumers through the first quarter of 2010, while they had already started loosening for corporations, the Fed survey data show.

    * If they hoped to pump up bank earnings so that Banks can tap the public markets before the 2012 election they may well be on their way. (The Banks are now planning to pay dividends again.) EXCEPT that the mortgage market is feeling the effects of the MERS/robo-signer mess.

    If not at a bottom, the RE markets are close enough to attract investors – so a banker might expect that 2011 will see a (dramatic?) rise in mortgage loan volume (its no accident that QE2 targeted the 10-year).

    So how does QE2 really really work? If the above is correct, it allows Banks (mostly TBTF) to get trading profits and pump up margins (mortgages and small biz, mostly) prior to tapping the public equity markets. The Banks get a backdoor bailout and the Fed and Obama Administration get a political benefit.

  21. KnotRP

    QE is held up as the controlled burn tool that saves the economic forest from a raging fire. But QE is not a driptorch that can be applied with precision and skill; even the lowly economic profession itself admits one cannot control what is ignited by QE nor where nor when. So QE is really just a bunch of teenagers throwing lit road flares out the car window as they randomly drive through the Sierras during no-burn season.

    They are fire fighters only in the figment of their imagination.

  22. Chris Rogers

    Edward Sir,
    Great post, so good in fact I’d like to get it in a Journal I’m printing for April 1.
    Tried finding contact details on internet – FAILED!
    How do I connect?
    Paper will be published with 29 other papers, book to be distributed in North East Asia.
    One’s reputable, I’m actually hosting the Fed’s William C. Dudley and ECB’s Dr. Jurgen Stark in Tokyo and Hong Kong shortly.
    Chris Rogers
    christopher.rogers@irrna.org

  23. Toby

    Bernanke often speaks as if he believes reserves create loans. I prefer Janet Yellen, the Fed Vice Chair, and the way she recently explained how QE is transmitted to the real economy.

    What does “create” mean? And why is there debate about this? This is money we’re talking about, quite a fundamental part of the economy. You’d think they’d have figured out what’s going on in that department by now! It’s been a few years after all.

    Truth is, we cannot know where the money goes. It gets squirted into the ocean of the economy then disperses. What are the effects of such squirting? “How long is a piece of string,” is the rhetorical answer.

    In actual fact, all QE2 does is drain the real economy of interest income by swapping an interest-bearing government liability for a non-interest bearing government liability. This decreases aggregate demand in the economy. So the real economy effects of QE are to slightly lower aggregate demand. This is offset by changing interest rate expectations, which alter private portfolio preferences and risk premia, leading to credit growth, leverage and speculation, forces which should pump up the real economy.

    So what’s the net effect, what’s the net out here? We’re reducing aggregate demand since lower interest rates mean those who earn money from money have less income (what proportion of the economy lives this way?) while borrowing and taking risks become ‘cheaper’ which pumps the economy into more activity. Is that a zero? Are we in equilibrium at long last? (That was a joke, by the way.)

    Follow the money, huh? Problem is, we can’t. Where it goes is secret, or more prosaically, is impossible to follow since the dosh has no serial numbers, and if it does, its journeying is not tracked throughout the system. Anonymity and all that. So any technical ability economists might otherwise have to say clearly what is going on is profoundly hampered. No one can follow the money, such is forbidden by the mechanics of the system. So right where it really matters we have guess work in place of certainty. Not even the FED is aware of what is going on.

    Reserves create loans? Fascinating choice of words. Borrowers create loans by being, to some degree, credit worthy (although we all know how the rules are bent there). Banks lend to borrowers to earn money, and reserves … well, they can be massaged, right? No people on earth as creative as modern accountants, the way I figure it. And obviously, if banks don’t lend they don’t make a profit. Banks are businesses; they have to make a profit. Profits from money creation. Money making money making money, AS DEBT. And then there’s Ben B saying we should scrap the reserve requirement. Go Ben! It’s all a joke anyway, right!?

    The article is a good tracking of bullshit and jargon, in which obviously impossible Perpetual Growth is an unquestionable given. It’s as if the real world doesn’t have any relevance at all. So the article fails to address what really matters and what this is all about; globally sustainable management of resources. Why would humanity want anything else? Tracking how numbers are added to accounts then saying ‘it does some opposite stuff out there, somehow’ is, forgive me, a waste of time.

    We are in a sixth extinction event. All living systems are in a state of decline. We have peak oil and peak everything else and yet we pontificate endlessly on how many dollars can dance at the tip of an economy. We are f*cking insane. The environment does not care two hoots about our imaginary numbers that we can’t even track anyway. You’re right Ben. It is all a joke. Let’s scrap it and start again.

    In the end money is for buying and selling stuff. We need a simple system everyone and their Grandma can understand. The opening comment says it all, “Going to have to read this thru about 4 more times to wrap my head around it, but thanks for covering it.” Such confusion should not be necessary and is evidence of subterfuge and hoodwinking. Money is addition, subtraction, and percentages (and percentages only until we get rid of usury). That’s it. Or that should be it.

    Right now the system is based on debt, but needn’t be. A professor of economics I have come to respect, Franz Hoermann, says we are transitioning from ‘money as a good’ to ‘money as information.’ That’s a phrase that makes a lot of sense to me. We, as a species, are culturally addicted to a particular way of seeing ourselves and society generally, call it the Myth of Age, or the Story of the Times. It includes things like ‘earning a living,’ ‘survival only of the fittest,’ ‘I’m all right, Jack,’ ‘there’s no such thing as a free lunch,’ ‘objective facts,’ ‘hard science,’ and so on. This story is crumbling. It requires a stiff and permanent hierarchy keeping the dumb dumb and the good information only in the hands of the elite. But nothing lasts forever. The bumps and the Information War we are experiencing are the outer signs of this change, the closing of one chapter and opening of another. Actually, more than a chapter. A book is closing.

    We are beginning to write a new story which has cooperation, trust, and abundance at its heart. Debt-money will be unnecessary, will seem like a cruel joke, once we have taught ourselves, in as open and egalitarian a way as possible. how to set up a truly democratic system, political and monetary, that fosters cooperation and renders ‘growth’ unnecessary. What a wonderful world that would be.

      1. Toby

        Agreed, but creative problem solving as guided by whatever wisdom we can muster regarding sustainability, and the very sobering knowledge that peak everything, while not ‘good news’ appears to be what all peer-reviewed journals are telling us. I’m no doomer, I’m just pragmatic. Solutions which don’t account for where we are at as an animal on a planet we totally depend on for our continued survival are seriously flawed at best, a deadly distraction at worst.

        Seriously, just because we’ve had it ‘good’ burning oil for the last century or so does not mean it’s plain sailing from here on in. Perpetual economic ‘growth’ is not where the solutions lie. Steady state growth is where we need to be looking, and the connotations of that are profound. The ‘strengths’ of the system that got us here — essentially technology as tool (including money) to linearly exploit finite resources as if there were no tomorrow — have become problems. Let me repeat that: Old strengths are new problems. It’s tough learning that.

        Culturally, we are still blinded by our own success and the excellence of the propaganda that keeps us conspicuously consuming as if it were a birth right. Please see the very sobering BBC documentary from the late 90s called “The Century of the Self” available on YouTube. Propaganda, public relations, marketing, it’s very powerful stuff, and we are a highly susceptible beast. A tale has been woven that still has us hypnotized. We need to break the spell before it’s tool late. If I sound dramatic it’s because the situation is in fact urgent. Just because markets still ‘work’ does not mean that living systems across the planet are doing fine. The market does not give a shit about the environment. It can’t. It was not designed to. Some see that as a strength for pete’s sake!

        In short, demote money, promote wealth. The solutions are there: democratic money, ‘debt’ and interest free; resource-based economics; renewable energy; eco-cities; steady state growth; etc., etc. We have the know-how and the resources. Only our cultural addictions and dumbed-down blindness to the urgency of the situation stand in our way. No doom, just honesty.

  24. Max424

    MMT all the way, baby! Hey, it’s our last chance, it really is.

    And, think about this too; if we implemented the MMT ethic as a nation, as an added bonus, we wouldn’t have to listen to metronomic Republicans drone on, and on, and on, and on, about their g+ddamn grandkids. Wouldn’t that be nice?

    The Republicans would be forced to concentrate on what are more traditional matters of concern for them; like, why are we only fighting two wars simultaneously, when we could be fighting three — or even four* — simultaneous wars instead?

    * I’m thinking: add Libya, and Iran, to Afghanistan and the War on Terror. Iraq? I don’t think you can consider it a war anymore. But if you feel strongly that it is, then certainly feel free to add it to your own personal total, and call it 5 possible wars — simultaneous.

    Note: The War on Drugs is over — unless you live in Mexico.

      1. Toby

        No, the fact that an expression like “idle resources” can have any meaning at all is at the heart of the problem. As if resources existed just for humans to turn into ‘goods’ and only then have ‘value,’ otherwise they are ‘idle,’ and that this transformation should be done in ever increasing quantities, for ever, without caring about recycling and waste. As if that could possibly be a good system!

        MMT does not address this issue explicitly or inherently, and hence cannot be the ‘solution.’ It certainly removes some of the mystique around money, takes some of the nonsense of ‘inherent value’ out of the equation, which is good, but until we start addressing, deeply and explicitly, what costs really are, what true sustainability entails for humanity and our socioeconomics, that ‘earning a living’ is the wrong mode of thought, so to speak, and much else besides, we’re just rearranging deck chairs on the Titanic. We can only ‘enjoy’ such triviality for so long.

        1. mansoor h. khan

          Toby said:

          “what true sustainability entails for humanity and our socioeconomics, that ‘earning a living’ is the wrong mode of thought, so to speak, and much else besides”

          Agreed. MMT is not an answer to everything but it is a good place to start to clear-up our heads about how money really works.

          Nature abhors imbalance and injustice.

          For example, imbalance of electrical charges in the clouds vs. the earth’s surface will lead to lightning and thunder. Too much imbalance in social relations (too many people starving while many living in luxury in the same community) usually leads to violence and war. Taking of too many wrong risks causes a financial system to collapse, etc.

          Therefore our job is to discover these laws of balance in nature (physics and chemistry) and in humans (economics, psychology) and use them to try to achieve our goal of maximum peace, fulfillment, fun and material comforts based on what these laws tell us.

          Mansoor

          1. skippy

            Mansoor…I wish you the best…thousands of years…programing…in need of reduction…the enemy, of us all…sigh.

            Skippy…the universe is the final abrogator and its talking quite loudly methinks…will we hear its call.

  25. fresno dan

    Wonderful, wonderful post. A very good explanation of a very convoluted subject. Really helps to clarify what is going on.

    “This is offset by changing interest rate expectations, which alter private portfolio preferences and risk premia, leading to credit growth, leverage and speculation, forces which should pump up the real economy.”

    One thing I cannot find on FED websites is, How much credit can an economy support? If one has a HELOC of 100K, and is 25% underwater on the mortgage, would one borrow, or would a bank lend to such a credit applicant? Should one borrow?

    I wonder if the FED or anyone has done a study not only addressing how much of the QE has been used for trading and speculating in financial instruments, and how much to actually start a business or make a consumer loan?

    1. mansoor h. khan

      Skippy said:

      “Skippy…the universe is the final abrogator and its talking quite loudly methinks…will we hear its call.”

      I disagree. The creator of the universe is the final abrogator.

      Mansoor

      1. skippy

        Mysticism has been with us a long time, yet, has failed so miserably (always too many unbelievers..cough GFC). Methinks clinging to mommy and daddy does not make us strong…humanity must grow up…lest we become an emperor still attached to a wet nurses mental teat.

        Skippy…financial theory will not safe guard us from the universes machinations. Go look at the fossil record…eh.

        1. mansoor h. khan

          Skippy said:

          “Skippy…financial theory will not safe guard us from the universes machinations. Go look at the fossil record…eh.”

          Maybe if the species in the fossil record had developed financial theory which is in accordance how the universe actually works then they would be blogging with us on internet too right now.

          Mansoor

          1. skippy

            ROFLOL…the absurdity of such a broad sweeping statement which repudiates every hard gleaned bit of empirical evidence to date..is well…Victorian at best.

            Skippy…will it be mummy’s on the dining table, ensuring entertaining after meal conversation?

  26. Mansoor H. Khan

    Skippy said:

    “ROFLOL…the absurdity of such a broad sweeping statement which repudiates every hard gleaned bit of empirical evidence to date..is well…Victorian at best.”

    So the knowledge and creativity which produced the internet is not part of the empirical evidence what of humans are capable of?

    Mansoor

    1. skippy

      “So the knowledge and creativity which produced the internet is not part of the empirical evidence what of humans are capable of?”

      —-

      as compared to the *double helix* ….NO

        1. Skippy

          Prove it empirically[!] or resign your self to submitting mystical aspirations with out evidence, save your own beliefs, which you have no right to hold above others.

          Skippy…mysticism is personal cowardice, in the face of which we have no control over..morte…which is a really bad direction in understanding the universe…we live in…eh. If this planet was to blow up tomorrow…the rest of the universe would still exist and do what ever it was…we are insignificant too its machinations.

  27. gunste

    The machinations of the Fed spell only one thing to me, personally: they have lowered the interest rates I can get on the substantial savings I have with the result that my earned income rates are negative.
    In addition, following the hollow mouthings by George W. Bush that he favored a “strong dollar”, the currency exchange of the dollar is ever downward. In 1978, it cost $0.27 to buy a CHF. Today, it requires $1.07.That provides the difference between how the two countries manage their finances. Even the Canadians do better, with the CA$ now more valuable than the US$.
    At the same time, the government has made it more difficult for the individual to have bank accounts in foreign currencies. The IRS has scared the Swiss from allowing individual accounts with US addresses. The Canadians make things difficult too – you have to go there to withdraw funds.
    All in all, the plutocracy benefits in is kept afloat, while they have also bought up the Congress.

  28. Jonathan

    The Fed already owns more government debt that enyone else. What happens when they own all of it? Who are they going to buy it from then? themselves???

  29. flow5

    Don’t you find it contraditory that if QE2 is ineffective & lowers aggregate demand (by eliminating interest income), then MMT will be even less so?

    MMT is the product of morons. To lower long-term interest rates you reverse REG Q ceiling regulation (just like the 1966 paradigm). Bankers pay for what they already own. I.e., the source of time deposits to the CB system is demand deposits, directly or indirectly via the currency route or the banks undivided profits accounts.

  30. Alan Hanson

    Interesting article but much of it seems to be based on the grand wizardry of Bernanke and company. I think the article is fatally flawed by the statement “If the Fed is buying government paper, it is essentially trading one government liability for another.”
    Basically treasuries are purchased from the US government by third parties using the third party’s money. This moves money from one party to another but the total amount of money remains the same. When the bond becomes due the money goes back to the bond holder.
    When the Fed buys treasuries or bonds it also needs money. The problem is the Fed has no money, so it creates some (the wizardry bit). Now the money the Fed creates goes to the bond holders but the bond holders have already paid money to the government. So now we have double the money. The extra money could be removed if the government pays the Fed and the Fed destroys the money. However, that is not going to happen because the US government will be running deficits until the whole thing explodes.

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