Quantitative easing has been a controversial policy even among the financiers who benefitted from it. The Fed has brushed those critics off, its confidence based on the fact that the economy didn’t go into a Great Depression-style black hole, which Fed officials believe was the result of its ministrations. One suspects the central bank regards its critics as an uninformed lot: goldbugs and hyperinflationists, right-wingers who don’t like government intervention in markets, pinkos who don’t like banks.
But there’s a world of difference between saying that the alphabet soup of special programs, which did shore up all sorts of players who didn’t have direct access to the Fed’s coffers, benefitted, and to say that QE, which didn’t begin until March 2009, was a plus to the economy. (And the cheery view of the Fed’s “success” during the crisis brushes by the fact that the Fed was fixated on rescuing only the financial system, and never even considered ways to do that, like restructuring debts, that would also have helped households and real economy businesses).
In addition, QE and its fellow traveller, ZIRP, has imposed a huge tax on retirees and savers, who can’t find high yielding, safe assets. The central bank believe they’d of course do the rational thing of either spending more of their principal or going into riskier assets (Gazprom, anyone? It has a nice 5.3% yield, although you would have done even better buying it six weeks ago). Instead, most are hunkering down and trying to make do on lower income.
In in a CNBC opinion piecePaul Gambles, the managing partner of MBMG Group, provided an elegant kneecapping of QE based on central bank research. Many of the arguments will be familiar to NC readers.
Gambles starts out by stressing that central banks are working from the wrong model of how lending works and the role it plays in economic expansion. He doesn’t use the term “loanable fund model” but he points out that banks don’t lend out of savings, that banks create credit based on demand for loans. The shorthand is “loans create deposits”. And what is devastating is that the Bank of England has gone on record calling out the “earth is flat” orthodoxy. Here’s Gambles’ layperson-friendly summary:
The findings in question are contained in the BoE’s Quarterly Bulletin. The paper’s introduction states that a “common misconception is that the central bank determines the quantity of loans and deposits in the economy by controlling the quantity of central bank money — the so-called ‘money multiplier’ approach.”
This “misconception” is obviously shared by the world’s policymakers, including the U.S. Federal Reserve, the Bank of Japan and the People’s Bank of China, not to mention the Bank of England itself, who have persisted with a policy of quantitative easing (QE).
QE is seen by its adherents, such as former U.S. Federal Reserve Chairman Ben Bernanke, as both the panacea to heal the post-global financial crisis world and also the factor whose absence was the main cause of the Great Depression. This is in line with their view that central banks create currency for commercial banks to then lend on to borrowers and that this stimulates both asset values and also consumption, which then underpin and fuel the various stages of the expected recovery, encouraging banks to create even more money by lending to both businesses and individuals as a virtuous cycle of expansion unfolds.
The theory sounds great.
However it has one tiny flaw. It’s nonsense….
The credit which underpins economic activity isn’t created by a supply of large deposits which then enables banks to lend; instead it is the demand for credit by borrowers that creates loans from banks which are then paid to recipients who then deposit them into banks. Loans create deposits, not the other way round.
Gambles points out that the Bank of England tries to salvage its reputation by claiming that QE nevertheless did some good by lowering interest rates which might have generated some additional (stimulative) borrowing. Gambles will have none of that:
…. the elasticity or price sensitivity of demand for credit has long been understood to vary at different points in the economic cycle or, as Minsky recognized, people and businesses are not inclined to borrow money during a downturn purely because it is made cheaper to do so. Consumers also need a feeling of job security and confidence in the economy before taking on additional borrowing commitments…
Ben Bernanke positioned himself as a student of history who had learned from the mistakes of the past. Dr. [Andrea] Terzi [Professor of Economics at Franklin University Switzerland] questions this, “This view that interest rates trigger an effective ‘transmission mechanism’ is one of the Great Faults in monetary management committed during the Great Recession.”
“The reality is that the level of interest rates affects the economy mildly and in an ambiguous way. To state that monetary policy is powerful is an unsubstantiated claim.”
This echoes a echoes a longstanding NC theme, that putting money on sale won’t induce businesses to borrow…unless the cost of money is a major factor in the cost of goods or services. What might those businesses be? Financial services companies, natch.
But here’s the part that is the real killer:
It may even be that QE has actually had a negative effect on employment, recovery and economic activity.
This is because the only notable effect QE is having is to raise asset prices. If the so-called wealth effect — of higher stock indices and property markets combined with lower interest rates — has failed to generate a sustained rebound in demand for private borrowing, then the higher asset values can start to depress economic activity. Just think of a property market where unclear job or income prospects make consumers nervous about borrowing but house prices keep going up. The higher prices may act as either a deterrent or a bar to market entry, such as when first time buyers are unable to afford to step onto the property ladder.
This is the exact opposite of the Fed’s beliefs, that the wealth effect encourages people to spend more. But what we saw in the cycle just past was that the spending consisted to a significant degree of tapping into accumulated paper wealth through borrowing. This wasn’t spending more out of discretionary income out of confidence; this was to a significant degree monetizing housing assets. And the value of those assets proved to be a hell of a lot more volatile than the Fed dreamed.
In the post-crisis era, with wealth even more concentrated, we’ve seen bifurcation: the wealthy indeed are spending again, as to some degree are upper income households. But they don’t have as high a propensity to spend as lower income earners. So an asset-price-driven recovery is almost bound to be flaccid. And that’s before you get to the huge negative that Gambles flags, that the Fed’s success in goosing asset prices, particularly housing, is actually undermining housing serving as a driver for a broader recovery (as it has in every past post World War II recovery).
So QE skeptics, I encourage you to circulate Gambles’ piece widely. It’s a refreshingly straightforward and compact treatment of why QE was never a good idea but why monetary economists like Bernanke couldn’t get past their dogma.