Do “Unconventional” Monetary Policies Work?

By Philip Arestis, Professor of Economics at the University of the Basque Country, Spain and Malcolm Sawyer, Professor of Economics, University of Leeds. Originally published at” rel=”nofollow”>Triple Crisis

The “unorthodox” Quantitative Easing (QE) monetary measures, along with another “unorthodox” monetary policy, namely negative interest rates, have been implemented by a number of countries in the years following the global financial crisis. This is as a result of the normal policy monetary instrument, the rate of interest, being reduced to nearly zero by a number of central banks. We discuss these measures but most importantly we discuss the extent to which they have been successful in terms of their targets.

QE includes two types of measures: (i) one is “conventional unconventional” measures, whereby central banks purchase financial assets, such as government securities or gilts, which boost the money supply; (ii) another is “unconventional unconventional” measures; in this way central banks buy high-quality, but illiquid corporate bonds and commercial paper. The purpose under both measures is not merely to increase the money supply but also, and more importantly, to increase liquidity and enhance trading activity in these markets.

A number of QE possible channels can be identified. There is the liquidity channel, whereby the extra cash can be used to fund new issues of equity and credit; thereby bank lending is influenced positively, which potentially can affect spending. The purchase of high-quality private sector assets, which aims at improving the liquidity in, and increase the flow of, corporate credit. There is also the portfolio channel, which changes the composition of portfolios, thereby affecting the prices and yields of assets (and thus asset holders’ wealth); the cost of borrowing for households and firms is also affected, which influences consumption (also affected by the change in wealth) and investment. Additionally, there is the expectations-management channel: asset purchases imply that, although the Bank Rate is near zero, the central bank is prepared to do whatever is needed to keep inflation at the set target; in doing so the central bank keeps expectations of future inflation anchored to the target.

The success of QE depends on four aspects: (i) what the sellers of the assets do with the money they receive in exchange from the central banks; (ii) the response of banks to the additional liquidity they receive when selling assets to the central banks; (iii) the response of capital markets to purchases of corporate debt; and (iv) the wider response of households and companies, especially so in terms of influencing inflation expectations.

There are doubts in terms of its effectiveness in view of the combination of QE and very low interest rates, which are close to zero. The ex-Governor of the Bank of England, Mervyn King (2016), has recently argued that when interest rates of all debt maturities are zero, “then money and long-term government bonds become perfect substitutes (they are both government promises to pay which offer zero interest), and the creation of one by buying the other makes no difference” (p. 183). However, there is a clear advantage in such a situation. This is that QE has made it easier for governments in terms of their fiscal policies because it provides a ready buyer for government debt. Without this facility, there would be serious difficulties in that governments may be seriously constrained in terms of the degree of their fiscal initiatives.

Another unconventional monetary policy, recently introduced by a number of central banks, is that of negative interest rates. As central banks have pursued QE, they have had to broaden the definition of assets that are included in their QE activities; this is as sovereign debt alone cannot satisfy central banks’ QE operations. It is the case that as options for further QE diminish, negative interest rates have become a new toolkit of monetary policy. A number of central banks have pushed their interest rates into negative territory, in an attempt to increase inflation expectations and raise inflation rates to their targets, as well as enhance growth rates. Negative interest rates are viewed by policymakers as part of their strategy to raise worryingly low inflation rates and offset downward pressures on inflation expectations. Negative interest rates are expected to drive down borrowing costs for business and consumers, and thereby redirect capital into higher-return investments; also to persuade savers to spend. Furthermore, lower interest rates are expected to weaken the country’s currency, thereby stimulating growth through more competitive exports. Such results would also increase inflation rates towards the central banks’ target inflation rates, usually 2 percent. However, this monetary policy experiment would only be successful if banks are willing to lend more; and its introduction has been accompanied by doubts as to whether this can be achieved in view of widespread volatility in financial markets, stagnant economies and poor economic growth; and most importantly poor expectations for future growth.

A further problem with the negative interest rates ‘unconventional’ monetary policy type is that it could produce reductions in the velocity of circulation of money. As such this type of “unconventional” monetary policy would not produce the expected results as envisaged by the proponents. So long as money (whether in the form of bank deposits or cash) maintains a zero rate of interest, it becomes a relative attractive financial asset when bonds offer a negative nominal rate of interest.

Low rates of interest on bank loans are argued to encourage investment thereby stimulating the economy. Apart from doubts on the size of such an effect, the other side of the coin is that those with accumulated savings face lower income (from interest rate payments). The retired who directly or indirectly rely for their income on interest payments have lower income, and have to lower their consumer demand.

It is also the case that negative interest rates can cause disruption by jeopardising the insurance companies and pension funds sectors through lowering their incomes. Under such circumstances both insurance companies and pension funds may shift the composition of their portfolios to risky assets, thereby adding to asset price bubble pressures, and could potentially create another type of the 2007/2008 international financial crisis. A further serious concern is the impact of negative interest rates on the rather fragile banking sectors. Those institutions, which are unable to increase lending, or pass the costs of negative interest rates on to their depositors, face a serious squeeze on their profits with serious implications on their ability to provide credit. Indeed, a prolonged period of low and negative interest rates may discourage lending as the net interest rate merging becomes smaller.

We may, therefore, conclude that “unconventional” monetary policies may be very unproductive and could potentially create further problems and crises.


King, M. (2016), The End of Alchemy: Money, Banking and the Future of the Global Economy, Little, Brown: London.

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  1. washunate

    We discuss these measures but most importantly we discuss the extent to which they have been successful in terms of their targets….We may, therefore, conclude that “unconventional” monetary policies may be very unproductive and could potentially create further problems and crises.

    What? Public policy has been very productive. It’s a huge success. Our leadership class possessing different goals is a very different problem than their policy choices not accomplishing what they want accomplished.

    1. craazyman

      How many helicopters would they need? When they talk they never say. They make it seem like it’s one helicopter, like the Platonic Ideal of “helicopter” hovering omnipresently over everywhere it needs to hover, as if it knows and extends itself instantaneously and effortlessly, materializing like a dream image and dropping dream money that becomes real the way rain becomes real from nothing but sky.

      If you assume 1 helicopter per, say, 1000 people. That’s about 350,000 helicopters. You could use fewer in highly populated areas, but you’d need lots and lots of helicopter time to cover, say, Wyoming. It would be all add up to 350,000 helicopter equivalents

      Where are 350,000 helicopters going to come from? From helicopter money? You need the helicopters BEFORE you can drop the money! And you need the money to pay for all of them. It’s an infinite loop of impossibility.

      This will never work they way they think it will.

      1. Whine Country

        There are approximately 3 million in the top 1 percent of the population so 3 million divided by 350,000 equals 9 helicopters. Were you thinking of something different? If you want it, here it is come and get it… we dropped it in front of your 6 car garage.

        1. craazyman

          9 is a lot less than 350,000.

          I had forgotten about the pilots. Where on earth will 350,000 helicopter pilots come from?

          None of this makes any sense at all if you think about it.

          Even if they had 1 helicopter drop the trillion dollar coin, that’s only 1 coin! You’d have to take it to a bank and break it down into 10s and 20s. Can you imagine?

          What if somebody found it and didn’t know it was a trillion dollar coin? They might use it in a Laundromat, washing clothes. You’d have to drop it where rich people live, where they don’t use Laundromats. But then they might not have any reason to spend it. What good would that do?

          1. Whine Country

            Craaz – If you tried to cash a trillion $ coin the bank would first make you deposit it and put a 5 day hold on it. They would then sell a $1 trillion investment and take the other side of the transaction. Then they would file bankruptcy in Panama where the funds were tied up in a secret account. While in bankruptcy, of course the officers and managers would have to be hired to continue to run the bank (to protect the creditors). Eventually, when the $1 trillion has been used up via salaries, bonuses and sweetheart contracts to their other cronies, the bank would emerge from bankruptcy using TARP II funds for capital. So, I like my way. 9 helicopters drop all the money in front of each of the 1 percents’ 6 car garage and boom – it’s over in a day. (Actually I was going to propose a drop like in “The Magic Christian” where only the 1 percent could attend but then I figured they would just hire dummies like us to get the shit on us and they would still get the money) You know, if the stuff they’re doing to us wasn’t so outrageous and, you know in “your” face, we’d have stopped them long ago.

          2. craazyboy

            There is Big Bazooka Theory, tho I don’t know if it’s been discredited yet or not. Once and a while that happens, but it may take a century. Anyway, the ratio is 99 to one, so if you were using a Big Bazooka, you would need 99 helicopters. Which really isn’t that many, and people wouldn’t need to walk that far from JFK Airport to pick up the money.

  2. Jim Haygood

    An apple vendor has 100 apples for sale at a dollar apiece. But they aren’t selling.

    In QE1, the vendor increases his stock to 300 apples. Still no sales.

    Determined to change his luck, the vendor lays in a massive QE2 inventory of 1,000 apples. Not one sells.

    “When the market gives you too many apples, make apple pie!” wisecracks a bystander.

    1. RabidGandhi

      It’s because the apple vendor is inefficient. Fire her and outsource the apple stacking to Filipinos who will work at 1/10th the wage. Then invent an app for more innovative stacking to fit even more than 1,000 apples on the cart. Hire middle managers and efficiency experts to streamline the cart and the Filipinos. ReFi the cart to pay for the new administration costs and hedge the apples with pie derivatives. Do a double-Irish to eliminate tax liabilities and use the savings for contributions to pro-apple politicians who will get you some sweet subsidies (more apples).

      1. Whine Country

        Your scenario would be hilarious if not so close to what is going on. Don’t know whether to laugh or cry. :) Seriously, when what you suggest is done with free financing, you get a huge bump in $ GNP and you end up with… nothing other than more debt. When enough people realize that this is really what is going on in a large scale – we will finally be closer to solving the problem.

    2. Uahsenaa

      This is what is so infuriating about monetary policy, at least as commonly practiced. Rather than simply direct money where it’s actually needed (as in stimulus of some kind, be it a job guarantee or even something as politically unpopular as direct cash transfer [can I open a FED account?]), instead we rely on a Rube Goldberg machine of handing over money to one actor A (a bank) who we hope will hand it over to another actor B (an employer) who we hope will hand it over to those the money actually needs to get to (consumers). Never mind the fact that both actors A and B have clear incentives to hold onto the cash or use it for purposes that have nothing to do with routing the money to where it’s needed to stimulate the economy.

      Of course doing it this way, as RabidGandhi makes clear, keeps the whole neoliberal boondoggle going, which seems to be the ACTUAL purpose of QE, not stimulating the economy.

      As someone who doesn’t come from finance or rely upon it professionally, this whole thing makes me seethe with rage. I can’t even resort to parody.

      1. Spencer

        “direct money where it’s actually needed”

        That’s what income redistribution is all about. The upper quintiles save most of their income. And unless the circuit income velocity of funds is maintained (recirculated), a dampening economic impact is exerted.

        That was how the “golden era” in U.S. economics was achieved.During the decade before 1965, the annual compounded rate of increase in our means-of-payment money supply was about 2 percent. Thus for the period 1955-1964, the rate of inflation (based on the Consumer Price Index) increased at an annual rate of 1.4 percent. Unemployment averaged 5.4 percent.

        This was a period where savings were “put to work” (before the 5 successive rate hikes in Reg. Q ceilings for just the ABA (public enemy #1).

    3. Tim

      Throwing good money after bad.
      Can a MMT person tell me with confidence this money will result in an increase of inflation relative to what it would have been. If not then it is also a stealth tax on anybody with savings or a stagnant income.

      1. RabidGandhi

        I don’t know if I qualify as an “MMT Person” but the idea that QE will necessarily lead to inflation is not something preached by MMTers, and it is very much belied by the facts. Since the increase in the monetary supply barely enters the real economy and the velocity of money does not increase notably, central banks are still far below their 2% inflation target, even after years of QE.

        The idea that QE would stimulate inflation is a trickle-down/supply-side philosophy of the anti-MMT central bankers who ascribe to the “More Apples!” theory Comrade Haygood illustrated above. MMT, on the other hand (as far as I understand it) would reject the claim that “inflation is always and everywhere a monetary phenomenon”.

        If you’ve got time, Randy Wray gives a longer explanation of this here.

  3. JIm Thomson

    Bill Mitchell has explained very clearly, on numerous occations, why these policies do not work, and cannot work. His most recent discussion was earlier this week, regarding Japan,
    The same considerations apply to Europe.
    He deals with the mythical “helicopter money”, too.

    1. Spencer

      Bill Mitchell doesn’t understand money and central banking. Savers never transfer their savings out of the commercial banking system (unless they are hoarding money). Savings flowing through the non-banks never leave the CB system. This applies to all investments made directly or indirectly through the non-banks. I.e., the non-banks are the CB’s customers. They are not in competition with the NBs (contrary to the pundits that deregulated them). The CBs simply pay interest to attract and concentrate deposits in a specific geographical region.

      Net changes in Reserve Bank Credit since the Treasury-Reserve Accord of March 1951 are determined by monetary policy objectives. Paying interest to capture deposits is tantamount to redlining or redistricting (monopolistic price practices by the oligarchs). The lending capacity of the CBs is dependent upon monetary policy, not the savings practices of the public. The CBs could continue to lend even if the non-bank public ceased to save altogether.

      When Dr. Alton Gilbert, senior monetary economist, FRB-STL, wrote “Requiem for Regulation Q. What it Was and Why it Passed Away”, Gilbert asked the wrong question: His implicit and false premise was that savings are a source of loan-funds to the banking system. Thereby in his analysis, Gilbert assumes that every dollar placed with a non-bank deprives commercial banks of a corresponding volume of loanable funds.

      Gilbert asked: Was the net interest income on loans/investments derived from “attracting” these savings deposits greater than the interest attributable to the direct and indirect operating expenses of this “funding”?

      I.e., the CB’s earning assets, which are erroneously regarded as being derived from savings, actually were already in existence before the time/savings deposits even came into being! CBs, as a system, simultaneously pay for all their earning assets with new deposits. The complete deregulation of interest rates means that the banks, which pay for something that they already own, are now, collectively, much less profitable (lower ROE and NIMs for both the NBs and CBs). The 1966 S&L credit crunch is the economic paradigm.

      All time/savings deposits are the indirect consequence of PRIOR bank credit creation. The source of all time/savings deposits to the CB system is other bank deposits, directly or indirectly via the currency route or thru the CB’s undivided profits accounts. I.e., CB time/savings deposits, unlike savings-investment accounts in the “thrifts” (non-banks), bear a direct, one-to-one relationship, to transactions accounts. As time deposits, TDs, grow, transaction deposits, TRs, are depleted, pari passu, and vice versa. And the growth of all deposits is traceable to the expansion of bank credit.

      1. Alejandro

        Given your inflated knowledge, I ask strictly as a student. Is there a role for fiscal cybernetics, i.e., matching real needs with means? Also, are credit ‘bubbles’ defined by exceeded debt carrying capacity? AND, are there monetary solutions to inequality and other so-called “defining issues of our time”? Lastly, by ” hoarding money”, are you claiming that money is a commodity?

  4. Doctor Duck

    I’m relatively unread in these matters so this may seem like a naive question, but…

    Ir seems as if both QE and extra infrastructure spending represent ‘government’ money entering the economy as a stimulus. It’s easy to see how infrastructure spending benefits (some) companies, workers and society as a whole. But what is the parallel benefit from QE? Does the economy benefit directly or is this a ‘trickle-down’ bonus from helping owners of assets?

    1. Jim Thomson

      Go to Mitchell’s blog, referenced above, and proceed to his earlier articles.
      It takes some study to understand all this.

    2. Jim Haygood

      The latter. Typically the economy doesn’t benefit directly, because the supplier of QE credit (the Fed) has no control over how it’s used.

      Post-2008, Fed credit expanded to offset a shrinkage in private credit. Paul Kasriel monitors the sum of both sources of credit:

      Is it likely that the pace of U.S. economic activity will slump significantly between now and September 21 [next FOMC meeting]? Not if the behavior of “thin-air” credit has anything to do with it. (Everyone may imbibe now.)

      Chart 3 shows that the sum of commercial bank credit and the monetary base (currency in circulation and depository institution reserves at the Fed) has grown at an annualized rate of 4.8% in the three months ended June.

      Although 4.8% is not a blistering pace in an historical context, it does represent a rebound from its growth slump in December-to-February period.

      And asset prices have rebounded accordingly from their Dec-Feb slump. Feed the magic beanstalk, and watch it grow. :-)

      1. Spencer

        Kassriel’s stupid. CB credit omits, CU, S&L, and MSB credit. And they became commercial banks after the S&L crisis.

        1. Jim Haygood

          Using commercial bank credit (representing 86% of all deposits, including the largest players) is no different than using the S&P 500 index (representing 80% of U.S. market cap, including the largest players) as a proxy for equity trends.

          It works. The perfectionists bark fecklessly, but the analytical caravan rolls on, using the data that’s timely available.


          1. Spencer


            True enough. That’s how one makes comparisons, using rates-of-change (not absolutes). But that masks the problem (that there is no difference between money and liquid assets).

            Money is the measure of liquidity, the yardstick by which the liquidity of all other assets is measured (viz., bank debits, money actually exchanging counterparties). Any other interpretation becomes mired in a futile discussion of relative degrees of confidence and liquidity.

            In almost every instance in which John Maynard Keynes wrote the term bank in “The General Theory of Employment, Interest and Money” published in Feb. 1936 (his magnum opus), it is necessary to substitute the term financial intermediary (non-bank) in order to make Keynes’ statement correct. This is the source of the pervasive error that characterizes the Keynesian economics (that there is no difference between money and liquid assets).

            This was the Gurley-Shaw’s thesis, e.g., the elimination of Reg. Q ceilings for just the commercial bankers, the DIDMCA of March 31st, 1980, the Garn-St. Germain Depository Institutions Act of 1982, the Financial Services Regulatory Relief Act of 2006, the Emergency Economic Stabilization Act of 2008, sec. 128. “acceleration of the effective date for payment of interest on reserves”, etc.

    3. Spencer

      Payrolls must be sufficient to buy the goods and services produced – at the “asked” prices. Unless money expands at least at the rate prices are being pushed up, incomes will fall, output can’t be sold, and jobs will be lost.

    4. paulmeli

      “seems as if both QE and extra infrastructure spending represent ‘government’ money entering the economy”

      QE is not a stimulus. It is an asset-swap that exchanges dollars for bonds (dollars that pay interest) with no change in the level of assets, only the composition of those assets.

      QE reduces the level of dollars (the interest) entering the economy.

      It is therefore a negative stimulus in math terms.

      If the agents receiving QE chase yield (risk) and succeed they have extracted dollars from someone else. This has to be so because QE didn’t add anything in the first place. The transaction is zero-sum (as every transaction is in nominal terms).

  5. Spencer Hall

    Tripe. QE, POMOs of the buying type, only expand the money stock when there’s a non-bank counterparty. But if excess reserve balances, IBDDs, are remunerated at the same time, then the non-banks suffer dis-intermediation (an outflow of funds or negative cash flow) – lowering AD:

    The protracted decline in money velocity stems from impounding savings within the CB system (when savings are idled, bottled up, and not “put to work”. Raising FDIC coverage to $250,000, flights-to-safety, exacerbated this.

    Every boom/bust since 1933 was due to monetary policy blunders. I.e., all these recessions were both predictable and preventable.

    Monetary policy objectives should be formulated in terms of desired rates-of-change, roc’s, in monetary flows, M*Vt (our means-of-payment money times its transactions velocity of circulation), relative to roc’s in R-gDp. Roc’s in N-gDp (though “raw materials, intermediate goods and labor costs, which comprise the bulk of business spending are not treated in N-gDp”), can serve as a proxy figure for roc’s in all transactions, P*T, in Yale Professor Irving Fisher’s truistic “equation of exchange” (where the proper index # provides clues to the overall economies’ “price-level”).

    Roc’s in R-gDp have to be used, of course, as a policy standard. This has been inviolate and sacrosanct for over 100 years.

    But we knew this already:
    “In 1931 this committee recommended a radical change in the method of computing reserve requirements, the most important features of which were…”
    # (2) “Requirements against debits to deposits”
    # (5)”the committee proposed that reserve requirements be based upon the turnover of deposits”
    This research paper was DECLASSIFIED after a 45 year hiatus on March 23, 1983.


    – Michel de Nostradame

  6. Chauncey Gardiner

    The cumulative rate of increase in QE-NIRP by the three large western central banks, now being conducted by the ECB and BOJ, has recently been running at an all-time high. Beginning in 2015 the Fed has simply been replacing runoff in its portfolio of MBS and US Treasuries in order to keep U.S. short-term interest rates below 0.5 percent.

    This coordinated oligarchic wealth concentration policy has since inception been largely about elevating prices of financial assets and real estate. Other than elevation of market prices, there has been little benefit spillover into the real economy.

    However, it is interesting that QE-NIRP policy pushback has emerged among an unlikely source of discontent, the primary dealers, in an unlikely place: Japan. So despite the forex implications there, perhaps this policy is nearing the end of its shelf life. Unfortunately this did not happen before US financial markets again entered bubble territory, in part due to the related carry trade and capital flight.

    If there was genuine interest among policy makers in improving the real economy, wage increases and policies to increase domestic fiscal spending and capital investment in productivity would play a far more prominent role, as well as a moderate and gradual increase in interest rates.

    1. Spencer

      “policies to increase…capital investment in productivity would play a far more prominent role”

      Commercial banks do not loan out existing savings (funds held beyond the income period in which received). CB held savings are lost to both investment and consumption. As more savings are impounded within the CB system, economic growth is retarded (if not offset by monetary policy).

      Unless savings are expeditiously activated, otherwise “put to work”, provided an outlet for, etc. a depressing debt deflationary economic spiral is fostered and perpetually reinforced. Then as money velocity and AD falls, the FED must offset declining AD. This is the policy mix that produces stagflation (as predicted in the late 50’s – before the word was coined in 1965), and perpetuates a declining standard of livings.

      Thus a long-term corrosive and debilitating impact on effective demands, esp. the demand for capital goods, and thus CAPEX, is continually exerted – whenever savings are not promptly matched with real investment outlets. The dire durable goods trend can only get worse.

  7. Ruben

    Another important and negative effect of unconventional monetary policies is well exemplified in the other post today “Oil Industry About To Be Burned Again By Fall In Oil Prices”, by Arthur Berman: malinvestment. In the absence of a proper lower bound for productive investment set by interest rates, at the faintest signal of oil price recovery rig count increases due to money desperately looking for a place to go.

    1. Spencer

      The FED’s largely responsible for the oil price decline (just like the housing bust). I.e., it was a demand side problem, not an increasing supply side condition. Monetary flows (peak to trough), the proxy for inflation, fell by 80 percent from 1/1/2013 to 1/1/2016 (that’s right, AD fell during QE operations). Oil fell by 70 percent.

  8. paulmeli

    “Do unconventional monetary policies work?”

    No. Monetary policies create liabilities in excess of assets that lead to instability in the system, especially if attempted without accompanying fiscal policies.

    Banks do not create the funds necessary to pay the interest, only the principal.

    Virtually all of the dollars in existence are owed to the banking system. What does that say about the level of our savings?

    1. Spencer

      “Monetary policies create liabilities in excess of assets that lead to instability in the system”

      Right. There is an excess of savings over investment – exerting a contractive influence. Interest is the price of loan-funds, not the price of money. The price of money is the reciprocal of the price-level.

  9. Spencer

    Joint Staff Report: The U.S. Treasury Market on October 15, 2014
    performed by:
    U.S. Department of the Treasury
    Board of Governors of the Federal Reserve System
    Federal Reserve Bank of New York
    U.S. Securities and Exchange Commission
    U.S. Commodity Futures Trading Commission
    “On October 15, 2014 (“October 15”), the market for U.S. Treasury securities, futures, and other closely related financial markets experienced an unusually high level of volatility and a very rapid round-trip in prices. Although trading volumes were high and the market continued to liquidity conditions became significantly strained. The yield on the benchmark 10-year Treasury security, a useful gauge for the price moves in other, elated instruments that day, experienced a 37-basis-point trading range, only to close 6 basis points below its opening level. Intraday changes of greater magnitude have been seen on only three occasions since 1998 and, unlike October 15, all were driven by significant policy announcements. Moreover, in the narrow window between 9:33 and 9:45 a.m. ET, yields exhibited a significant round-trip without a clear cause, with the 10-year Treasury yield experiencing a 16-basis-point drop and then rebound. For such significant volatility and a large round-trip in prices to occur in so short a time with no obvious catalyst is unprecedented in the recent history of the Treasury market.”

    This was as I predicted. The next dislocation will be at Nov-month end.

  10. Leonard

    Zero or negative interest rates would not be a question today if modern economies had used the income tax code to help control the primary home bubble of the 2000s. When primary home prices increased at a rate of more than two percent, the interest deduction should have been reduced, and the capital gains tax rate should have been raised on the sale of primary homes. To increase the value of money (debt) without raising cost of production, and consumption, the tax rate on interest earned on savings and bonds should have been lowered. These changes in the tax code would have helped control the “irrational exuberance” in the primary home market. After primary home prices returned to an annual appreciation rate of 2%, the tax code would automatically return to its previous rates and deductions.
    How would it work?
    Say we set a maximum appreciation/inflation rate of 4%. When the annual appreciation/inflation rate of an appreciation index reached 3%, only 50% of the interest earned would be taxable income. The interest deduction would also be reduced by 50%. The tax rate on realized long term capital gains would be increased by 50%. These changes would take place at the end of the year when people pay their taxes.
    If the appreciation/inflation rate increased to 4% the the tax rate changes would be 100%. The long term capital gains tax rate would go up to the taxpayers top rate. When the appreciation/ inflation rate went down the tax rates and deductions would automatically reverses themselves, at the end of the year to maintain aggregate demand and collateral prices.
    These changes in our tax code would encourage people to keep their finances in a more balanced situation. Therefore we would have a more steady economy. Keeping more people employed through all the cycles of the economy. Reducing deep recessions and high appreciation/inflation cycles and government social cost.
    Before interest rates can be lowered to stimulate an economy they must go up. The same thing must occur with tax rates. They must go up to be able to come down as they did during World War 1 and then lowered in 1921 then again in World War 2 and then lowered in 1961. Then again tax rates were lowered in 1981. Tax rates were raised by the first Bush President and President Clinton and then lowered by the second Bush President. The tax cuts were left in place for too long in 2000 helping to create the primary housing bubble of the 2000s’ and the financial crisis of 2008.
    The same thing occurred in the 1920’s when tax rates were decreased in 1921 from a top rate of 76% to 12.5% on long term capital gains and the top rate was lowered from 76% to 42%. The 1920s ended the decade with a financial crisis and the creation of the Great Depression. If the the tax rates had been changed as explained earlier, perhaps we could have avoided the experience of the Great Depression.

    1. Spencer

      History has been re-written:

      Paul Volcker’s version of monetarism (along with credit controls: the Emergency Credit Controls program of March 14, 1980), was limited to Feb, Mar, & Apr of 1980. With the intro of the DIDMCA on March 31st 1980, total legal reserves increased at a 17% annual rate of change, & M1 exploded at a 20% annual rate (until 1980 year’s-end).

      Why did Volcker fail? This was due to Volcker’s operating procedure. Volcker targeted non-borrowed reserves (reflecting no change in the “desk’s” operating procedure according Paul Meek’s (FRB-NY assistant V.P. of OMOs and Treasury issues), stated objective in his 3rd edition of “Open Market Operations” published in 1974: of “gauging the general availability of non-borrowed (interbank) reserves in the commercial banking system (predating Paul Volcker’s experimental and rhetorically couched approach in Oct 1979). ), when at times 10 percent of all reserves were borrowed.

      One dollar of borrowed reserves provided the same legal-economic base for the expansion of money as one dollar of non-borrowed reserves. The fact that advances had to be repaid in 15 days was immaterial. A new advance could be obtained, or the borrowing bank replaced by other borrowing banks.
      That’s before the discount rate was made a penalty rate in January 2003 (see: Walter Bagehot in his book Lombard Street: “lend freely and at a penalty rate). And the fed funds “bracket racket” was simply widened, not eliminated. Monetarism has never been tried.

      Then came the “time bomb”, (as Dr. Leland Prichard foretold), the widespread introduction of ATS, NOW, & MMMF accounts at 1980 year end — which vastly accelerated the transactions velocity of money, i.e., by an astonishing 96 percent in 2 years, from Nov. 1979 – Dec. 1981 (all the demand drafts drawn on these accounts cleared thru demand deposits (DDs) – except those drawn on Mutual Savings Banks (MSBs), interbank, & the U.S. government). Prior to that time, demand deposit turnover took 10 years to double from 1969-1979 (25-> 50) and 10 years to double from 1959-1969.(50-> 100).

      This initially propelled N-gNp to 19.2% in the 1st qtr. 1981, the FFR to 22%, & AAA Corporates to 15.49%. My prediction for AAA corporate yields for 1981 was 15.48%.

      By the first qtr. of 1981, the damage had already been done. But Volcker never changed policy (supplied an excessive volume of legal reserves to the banking system), as late as 1982-83 – producing a downdraft until June 1984

  11. Spencer

    Monetary flows (this is correct according to Dr. Richard Anderson, former FRB-STL senior economist and V.P.). He stated that required reserves are driven by payments. But “nobody at the Fed tracks reserves”.
    He is the world’s leading guru on reserves.

    parse; dt; proxy for real-output; proxy for inflation:

    1/1/2016 ,,,,, 0.07 ,,,,, 0.20
    2/1/2016 ,,,,, 0.02 ,,,,, 0.16
    3/1/2016 ,,,,, 0.04 ,,,,, 0.13
    4/1/2016 ,,,,, 0.04 ,,,,, 0.15
    5/1/2016 ,,,,, 0.05 ,,,,, 0.19 Brent oil peaks (actually peaked 6/9/2016)
    6/1/2016 ,,,,, 0.07 ,,,,, 0.15
    7/1/2016 ,,,,, 0.08 ,,,,, 0.12
    8/1/2016 ,,,,, 0.08 ,,,,, 0.17 sell stocks
    9/1/2016 ,,,,, 0.06 ,,,,, 0.14
    10/1/2016 ,,,,, 0.00 ,,,,, 0.13
    11/1/2016 ,,,,, 0.05 ,,,,, 0.13 sell commodities / buy bonds
    12/1/2016 ,,,,, 0.05 ,,,,, 0.05
    1/1/2017 ,,,,, 0.02 ,,,,, 0.08
    2/1/2017 ,,,,, -0.01 ,,,,, 0.07
    3/1/2017 ,,,,, 0.00 ,,,,, 0.06

    Another successively weak 1st qtr. 2017

    I.e., nothing’s changed in over 100 years.
    – Michel de Nostredame (histories’ greatest market timer)

  12. Sound of the Suburbs

    The IMF and many other Western organisations and individuals are experts, but they are experts in Neo-Liberal thinking and neoclassical economics which does not always come up with the right answers.

    Their expertise tells them that Government spending is bad and austerity is good, cutting Government spending will allow the private sector to fill the gap.

    David Cameron voiced the same opinion about the UK, it is the mainstream thinking of the West, unfortunately it is wrong.

    Richard Koo observed Japan’s progress after its massive real estate bubble burst in 1989, the private sector was in a balance sheet recession and would not borrow whatever the interest rate.

    The only thing that worked was fiscal policy to stop the money supply contracting.

    Every now and then Western experts (in wrong thinking) came along and told Japan that Government spending was too high and they must change their ways. They dutifully followed the advice, cut Government spending, and the economy took a turn for the worse until they increased Government borrowing again.

    Neo-Liberal thinking and neoclassical economics does not understand money and how it is created and destroyed and how this affects the money supply. This is why it comes up with the wrong answers like austerity which is the worst thing you can do when the private sector is not borrowing.

    Money and debt are opposite sides of the same coin.

    If there is no debt there is no money.

    Money is created by loans and destroyed by repayments of those loans.

    Before 1989 in Japan, tons of new debt was coming into existence and the money supply increased and fed into the general economy. It felt like there was lots of money about because there was.

    After 1989, hardly anyone is taking on new debt and everyone is making repayments, the money supply shrinks and gets sucked out of the general economy. It feels like there isn’t much money about because there isn’t.

    In the balance sheet recession when the private sector isn’t borrowing, there is little new debt and lots of repayments causing the money supply to contract.

    Government borrowing is the only way to stop the money supply contracting.

    QE doesn’t work because the money never enters the real economy as no one is borrowing as can be seen from the low inflation rates around the world.

    Richard Koo explains all with two fixes for the Euro on YouTube.

    “ACATIS Konferenz 2016, Mr. Koo, Surviving in the Intellectually Bankrupt Monetary Policy Environment”

    What the BoJ and ECB are doing is just silly.

    1. Sound of the Suburbs

      If Japan had not engaged in fiscal stimulus it would have spiralled into a 1929 type depression, these were the only two choices. (Greece was forced to take the other option.)

      Richard Koo has done the maths and says that Japan has done the right thing financially as well as avoiding all the pain and hardship of a 1929 style depression.

      The real lesson is not to blow debt inflated asset bubbles as they collapse with catastrophic consequences, this advice comes a bit too late as most nations have inflated massive real estate bubbles that will burst with terrible consequences.

      2008 wasn’t a one off “black swan event”

      “Minsky Moments”

      1929 – US (margin lending into US stocks)
      1989 – Japan, UK (real estate)
      2008 – US (real estate bubble leveraged up with derivatives for global contagion)
      2010 – Ireland (real estate)
      2012 – Spain (real estate)

      Irving Fisher looked at the debt inflated asset bubble after the 1929 crash when ideas that markets reached stable equilibriums were beyond a joke.

      Fisher developed a theory of economic crises called debt-deflation, which attributed the crises to the bursting of a credit bubble.

      Hyman Minsky came up with “financial instability hypothesis” in 1974 and Steve Keen carries on with this work today.

      Steve Keen saw the debt bubble inflating in 2005, three years before 2008.

      Some more stuff missing from today’s economics meaning no one sees the danger ahead.

      What is never mentioned about Greece is that it had a housing bubble too.

      The Greek housing bubble was larger than the Spanish housing bubble.

      Collapsing debt inflated asset bubble + austerity = 1929 style depression

      Adios Greece.

    2. philippe byrnes

      Thanks for the Richard Koo link. I try to search for his stuff every six months or so. From what I can tell he is one of the few to have a good handle on the “Through the Looking Glass” world of depressionary/debt deflation economics. And what he says is not encouraging.

      Big fan also of Steve Keen. The way the academic economics establishment has treated him is despicable. I hope he’s happy at his new position in the UK. He should be at Harvard or MIT.


  13. Eddy Vassie

    If the usual QE attempts fail, a central bank can take the more unconventional route of trying to prop up equity markets by actively purchasing shares of stocks on the open market. During the years after the financial crisis , central banks around the world did in fact engage in equity markets to some degree. Central banks enact monetary policy to change the size of the money supply and its rate of growth. This is normally done through interest rate targeting, setting bank reserve requirements, and engaging in open market operations with government securities. In periods of severe economic downturn, these tools become limited as interest rates approach zero and commercial banks become worried about liquidity .

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