A Question for the Money Printers
I am being serious with this one, so if you actually know what you are talking about–always a plus–please help me out. We’ve got lots and lots of economists (like Paul Krugman but also Scott Sumner and even Tyler Cowen) who think QE2 might help a little bit, but that it’s not enough to get the job done and restore full employment.
OK, Bernanke is going to create an additional $600 billion “out of thin air” as they say. Help me out here:
* According to that bastion of truth, the Bureau of Labor Statistics, the number of unemployed Americans is 14.8 million.
* With $600 billion, Bernanke could have hired each unemployed person to pick up litter, read Aesop’s Fables to orphans, change bed pans, etc. for an average salary of more than $40,000 per year (no health benefits).
* So if Bernanke were to do the above, the unemployment rate would immediately drop to 0%, especially if Congress discontinued federal unemployment benefits in light of the Fed subsidy.
* I anticipate that Sumner could argue, “Ah, but if people perceived this as a one-time Fed burst of inflation, then most of that new income would be saved. So Aggregate Demand wouldn’t actually rise enough to sustainably create full employment.”
* OK, but note that on Keynesian grounds, my hypothetical make-work Fed program–call it Laziness Easing–couldn’t possibly hurt anything. Especially if we assume that Bernanke promises he won’t repeat the experiment–since we don’t want current workers quitting their jobs in the hopes of getting on the gravy train next year.
* So what would Krugman et al. predict would happen in my scenario? That the official unemployment rate would drop to 0%, and then it would shoot back up to 9% or whatever in one year’s time? And that everybody would be perfectly rational Chicago-School type agents, and those unemployed workers would not think, “Maybe things will pick up in a year from now, so I feel safe spending some of this $40,000 paycheck this year”?
* To the extent that an actual Keynesian agrees with me that this prediction is ridiculous–that surely we couldn’t literally put every single person back to work for a full year, without that nudging the economy out of its pure Aggregate-Demand-slump–then can we all agree that the Fed’s current QE2 is a ridiculous failure?
(Incidentally, Tyler Cowen in his limited praise for QE2 acknowledges that there are “real” problems with the economy, so he could get out of this dilemma easier than Krugman or Sumner.)
“Bernanke is going to create an additional $600 billion “out of thin air” as they say”
Mistake number 1, QE does not create anything out of thin air. QE is just an asset swap and does not add net new financial assets to the economy. It appears you do not understand the mechanics of a QE transaction. Here is a very simple explanation.
http://pragcap.com/mechanics-qe-transaction
QE is a dangerous and a flawed policy, but for none of the reasons you cite (such as inflation). QE is a deflationary policy since it removes interest income from the private sector and boosts inputs cots via the portfolio re-balancing channel.
It appears you have a fundamental misunderstanding of the operational realities of a non convertible monetary system such as the US.
“With $600 billion, Bernanke could have hired each unemployed person to pick up litter”
Actually, no, he can not. It is illegal for the Fed to do this. Again, it appears you have a misunderstanding of the operational realities of the Fed. And since this false statement is the premise for the remainder of this post, the rest of this is post irrelevant.
A P Lerner:
I read the link you posted.
It explained that exchanging cash for treasury debt is not inflationary because it is just a matter of swapping one government liability for another.
OK, so in the following scenario, can you, without contradicting the link you posted, tell me which (if any) parts are inflationary:
The government repeals all taxes. In lieu of taxes, the treasury issues debt instruments to cover the federal budget. Private banks purchase this debt and immediately sell it on to the Federal Reserve.
“The government repeals all taxes”
Inflationary.
How is repealing taxes inflationary?
Lower taxes increases income in the private sector.
If your income taxes went to zero tomorrow would you not have more income to consume?
How will allowing people to keep more of their earnings increase the money supply, i.e. inflation?
Mr. Lerner, I understand how QE works. I’m saying, instead of doing that, what if the Fed wrote checks to Joe Smith to pick up litter.
If you want to say that’s illegal, OK, but I want to know what New Keynesians would think of the actual economic impact.
“Mr. Lerner, I understand how QE works”
I would respectfully disagree. By saying “Bernanke is going to create an additional $600 billion “out of thin air” is a mischaracterization of QE since nothing is new is created. It is simply an asset swap: swapping a non interest bearing note with a slightly less liquid, interest bearing one.
“If you want to say that’s illegal, OK, but I want to know what New Keynesians would think of the actual economic impact.”
Yes, it is illegal for the Fed to hire people directly as a monetary operation. I am not a new Keynesians, and would never want to speak for them, but I can not imagine why anyone would spend their time analyzing the economic impact of an illegal monetary operation.
The non interest bearing loan, of course, having been created electronically and not previously existent.
What the Fed is creating is money that we all trade in the economy. A Treasury security may be very close to money but it is not money. Further, the Fed is now buying longer term Treasury securities, which are certainly not money.
The ultimate proof of this is that daily people sell Treasury securities for money (and vice versa), if Treasury securities were money why would they do this?
Those selling the Treasury securities certainly want money for some kind of transaction, if they thought they could pull it off the transaction with the Treasury securities they, again, wouldn’t go through the cash/Treasury security exchange.
“What the Fed is creating is money that we all trade in the economy. A Treasury security may be very close to money but it is not money”
Actually, what the Fed is creating are reserves. Treasury securities are no different from reserves except they have a final maturity and an interest payment. Both are liabilities of the US government.
Do you not consider your savings account cash?
“The ultimate proof of this is that daily people sell Treasury securities for money “
Actually, most treasury trades are done on swap for other assets, like corporate bonds, MBS, and, sometimes, cash.
@ AP Lerner,
“Both are liabilities of the US government.”
A liability is a claim against an asset i.e. unconsumed production or “reserves” if you will. if there is no asset then there can be no “claim” against it so it is nonsensical to say that the Fed “creates” reserves by “creating” liabilities. reserves are “created” by consuming less than one produces not by running tokens off a printing press. one can swap liabilities just as one can swap assets but any liability is meaningless without the assets that underlie it. creating more liabilities (i.e. treasuries) without increasing actual assets (savings) is monetary inflation plain and simple. If all we needed was an Enron style accounting trick then the economy would have been back on track years ago. We all know that it does not work, main stream economists just don’t want to face the truth.
So just to clarify, all the 10 yr. treasury notes I own are not my assets?
“creating more liabilities (i.e. treasuries) without increasing actual assets (savings) is monetary inflation plain and simple.”
QE removes treasuries from the private sector. Doesn’t that contradict the above statement?
“reserves are “created” by consuming less than one produces”
Sounds like you may be confusing reserves with savings. Reserves are not savings.
AP
10 yr treasury notes are assets only so long as they remain the US govt’s liability, if/when they default they revert to useless paper. ditto for the US dollar. since the govt has cut the link between currency and the goods it represents the process you are describing is an Bernie Madoff style credit con game where the govt borrows money from you today which it will repay with money it will borrow from you tomorrow. at some point the party will end and you will realize that the paper “asset” you hold commands fewer and fewer goods and at that point you will wake up to the swindle and find out that the only thing you can do to “reserve” a portion of your income (if you have any) from rising prices is to get it out of the fiat paper money system.
Reserves are absolutely different than Treasury securities. Try and earn the 0.25% the Fed is paying on reserves with Treasury securities. Not going to happen.
Further a bank can go to the Fed any day of the week and demand cash for those reserves (without any other additional steps) Again, a Treasury security is near money but it is not money.
But the real key is not what is a liability of the government but what people use in everday exchange. They use cash, checking deposits, money markets. Have you attempted to pay your rent with a Treasury bond?
As far as swap transactions taking place, i never said they didn’t. All I said was that Treasury’s are sometimes exchanged (sold) for cash, meaning currency, a demand deposit etc.
If it was already cash, why would you have to go to a dealer and get a quote to sell it. If you want to convert one form of cash a demand deposit into currency, there is no quote. It’s exchanged $100 for $100 (with possible transaction fee) but no quote as to value.
Go to a bank today, tmrw and the next day and the day after that with a quarter and you will get five nickels if you want, go with a $100 bill and you will get five twenties if you want. Are you going to guarantee that I am going to be able to do the same thing with a 10 year Treasury note? Not a chance.
AP, I want to be sure I understand what you and the article you linked to are saying.
The Fed is not ‘printing money’ because, although it is creating cash to purchase treasury debt, this cash is not being ‘multiplied’ through the system, but being held in reserve by the banks. This will not increase the money supply (M2 or MZM) but effectively decrease the ratio of M2 (or MZM) to actual cash (which is not really a unique asset class, but basically a T-bill)?
The Fed is not ‘printing’ money because it does not create net new financial assets during QE. The process of QE involves the Fed swapping a highly liquid, non interest asset for a slightly less liquid, interest bearing asset. Essentially, swapping reserves for bonds.
So the net impact of QE is a change in the composition of the private sectors balance sheet, but the size of the balance sheet remains the same. Nothing new is ‘created out of thing air’, and the net impact to money supply is zero.
QE is an awful policy littered with unintended consequences. But inflationary, it is not.
AP,
Thank you, and thanks in advance for your patience, but your answer is still not clear to me. Perhaps I should rephrase my question – is the FED ‘creating’ cash (federal reserve notes) or not?
In your response you say the FED is not creating any ‘net’ assets – just changing the composition of the private sector balance sheets by giving them ‘cash’ in exchange for less-liquid, interest bearing assets. (The swap). Where is it getting the cash to make the swap? Is it creating the cash, or not?
No problem.
“is the FED ‘creating’ cash (federal reserve notes) or not?”
Yes. But that’s only one half of the transaction. It is also removing an asset (in this case, a treasury bond) from the private sector as well. So the net impact on financial assets in the private sector is zero, just the duration has changed.
So if cash and reserves count the same when determining the size of the money supply, couldn’t you say that the issuing of treasury bonds by the US Government is inflationary? And doesn’t the Fed enable the government to issue a much larget amount of treasury bonds by providing a secondary market for them? So wouldn’t QE still be inflationary, if indirectly?
“It is also removing an asset (in this case, a treasury bond) from the private sector as well”
…and this too is only half of the transaction since the US govt, in order to meet is liability, must either remove an equal amount of financial assets from the private sector through taxation or print the money to “repay” the treasury bond (plus interest )that is now held on the Feds balance sheet. Explain why you dont factor this bond into the equation. Why are treasury bond assets, which are liabilities of the US govt, not counted as part of the money supply? Money was printed to buy the bond and money will have to be printed to pay it off, either that or taxes must be raised/spending slashed in order to satisfy the liability without default.
Sumner already kind of did a post on this.
http://www.themoneyillusion.com/?p=6119
He uses a helicopter drop instead of employing people directly, but the reasoning is the same. It’ll probably cause hyperinflation inflation and it’s stupid when traditional tools haven’t been tried.
and here’s Delong for a Keynesian opinion.
http://delong.typepad.com/sdj/2010/07/helicopter-drop-time-paul-krugman-gets-one-wrong.html
OK – this is just after very quick reflection, but I agree this is precisely the sort of thing we need right now.
A lot of Keynesians have been saying “this couldn’t hurt – not a bad idea – but don’t expect miracles”. That’s been my position. So what’s the difference?
The difference, I think, is the extent to which stimulus (monetary, fiscal, or otherwise) gets translated into effective demand. If you simply print and hand out money it may never get translated into effective demand because we know people are currently demanding money and placing a high premium on liquidity. Satisfying that liquidity preference or creating inflation to make prices more flexible or whatever else may not hurt – but it’s not addressing the root problem.
Giving people money to do labor-intensive tasks may not either – it’s not consumer demand that is the biggest drag on the economy, after all. It’s investment demand. So, paying people to rake leaves may or may not help (it certainly doesn’t hurt to boost consumer demand or alleviate poverty) – but paying people to build roads and rail is going to boost consumer demand and investment demand, which is really where the shortfall is. The real problem is that instead of investing in real capital, people want to invest in idle capital. Infrastructure projects and the like would improve investment demand.
This is not to say that QE2 or passing out checks is a horrible idea. But there’s a reason why Keynes advocated first and foremost the “socialization of investment”, not the inflation of the currency or the “socialization of consumption”.
The one other thing I can think of is that sheer money creation will help solve the zero lower bound problem by creating inflation so that there’s not this ZIRP-induced rigidity in the interest rate. I buy this argument to a certain extent, but on the other hand – increasing investment demand should also take care of the zero lower bound situtaiton.
Idle capital is a redundancy. Capital is always idle until the moment it is consumed.
AP “hut tax” Lerner taught me everything I know about economics. His hero Warren Mosler explains how wonderful it is for a government to “monetize” a victim population:
The following is not merely a theoretical concept. It’s exactly what happened in Africa in the 1800’s, when the British established colonies there to grow crops. The British offered jobs to the local population, but none of them were interested in earning British coins. So the British placed a “hut tax” on all of their dwellings, payable only in British coins. Suddenly, the area was “monetized,” as everyone now needed British coins, and the local population started offering things for sale, as well as their labor, to get the needed coins. The British could then hire them and pay them in British coins to work the fields and grow their crops.
Check out page 26 of Mosler‘s amazing book. This book was promoted in the comments to the “Krugman in Wonderland” blog by AP “hut tax” Lerner himself. Mosler sets forth how Mad Monetary Theory “MMT” explains the “reality” of our super excellent fiat money system.
AP “hut tax” Lerner also sets us straight on the question of “Aren’t deficits just as bad as you have to eventually pay it back through taxes?”here:
No. Deficits are flows, not stocks. Ricadian Equivalance is a myth. Think about it this way, how much of your output do you send back in time to pay for Reagons deficits? Zippo. Public deficits = private savings.
And here, his hero
Paul McCulley of PIMCO (yes, that Paul McCulley of PIMCO) explains how the government need never pay back any of its debt:
But, you retort, the private sector is ultimately on the hook for the government’s liabilities, so how can those liabilities be considered the private sector’s asset? Simple: They can be sold for hard cold cash. To be sure, someday the government’s debt must be rolled over, or retired. But in real time, government securities are assets of the private sector (or the foreign sector). And for a fiat currency country, there is no reason to think that the debt cannot be rolled over, as such countries have a technology called a money printing press.
Since the basic purpose of Keynesian policy is the surreptitious transfer of wealth, purchasing power and assets primarily to the financial elite and politically connected, Prof. Murphy’s proposal would provide an open and obvious wealth transfer to the politically unconnected. As such, it could be a good lesson for the oblivious public about the true nature of Keynesian policy and Federal Reserve activities in general. Or, more likely, it might simply encourage more open and obvious looting through further money dilution.
yes, I agree!
Here is a different take on this post. Your hypothetical make work program exposes the psychological aspects of the Keynesian mindset. Keynesian economists are not primarily about economic progress, efficiency or production, they’re not even primarily about redistribution although it serves as a convenient moral cover. What the Keynesians are really about is power, they want to be the ones in charge calling the shots, directing resources and controlling consumption. If the Keynesians truly believed that printing money and dropping it from helicopters directly to the people would increase economic activity then they would advocate doing, on their own grounds, so as you have pointed out but it’s not about that since giving the money directly to the unemployed people will deprive them of the opportunity to give it to thier connected friends on wall street so they will have first dibs on the chance to profit from the inflationary stimulus at the expense of everyone else.
I think you’re being paranoid and conspiratorial here.
The fact is Keynesians have been insisting that it be done “their way” for two years now. We got a wimpy stimulus initially and now there’s not really any chance of anything else coming through.
So what is to be done? Sit back and keep bitching? That doesn’t seem helpful for anyone. Better to get behind a second-best option that has some prospect of happening and might do some good.
You can continue to take your conspiratorial outlook if you want, but I don’t think that’s very helpful. It’s also pretty obnoxious and insulting.
no, not paranoid, it is a fact that Keynsians have an infinite fixation for government intervention as the ideal solution for fixing every alleged market problem. Keynsians cannot seem to comprehend that markets function perfectly well on their own and if there is a problem it is most likely caused by government intervention. There must be some reason why government central planners think they are uniquly endowed with solutions that the rest of us lack and it if progress is to be made it must begin by confronting that hubris. Indeed, consider the fact that when Obama and team attempted to solicit ideas for fixing the economy from republicans and other economists to indicate is “open mindedness” the only idea that was explicitly not put on the table was for a reduction of government.
IIf all of that sounds conspiratorial then it is only becuase the facts speak for themselves. why else would no one even consider the possibility that they are a major part of the problem and not the solution?
“Keynsians have an infinite fixation for government intervention as the ideal solution for fixing every alleged market problem”
You’re right – paranoid was probably the wrong word. “Delusional” and “hyperbolic” seem more appropriate in light of this sentence (although my original “paranoid” was probably still appropriate to your claim that Keynesians are “about power”).
You don’t think Keynesians have pointed to loads of thing the government has done wrong? I think you’re hinging far too much on the insight that in certain circumstances we think government spending should go up. This is true. However, it is nothing like the claim that government has done no wrong.
“You don’t think Keynesians have pointed to loads of thing the government has done wrong?”
sure they have, but “wrong” in this context usually means “insufficient”, as in “…things would have been better if the government had done more of x instead of inadequate y.” You admitted as much in your own post.
As for the power comment, it is very simple. Keynesians claim that the problem with recessions is a lack of “effective demand” because, in general, consumers/investors have decided that it is in their own best interests to cut back on expenditures. In response to this, Keynesians proceed to spend their money for them through various nefarious means, QE being just one of them. So then tell me, if it’s not about power, then on what grounds can a Keynesian central planner exercise his own judgment in matters of production and trade but deny that same ability in others?
I predict Krugman would try to dismiss your idea as silly on its face, without attempting to refute it. I think you are right, your suggestion is completely consistent with their idea of how economics works, just more baldfaced about it.
But you are forgetting your most powerful Keynesian refutation of ‘unemployment will go back to 0%’ — the multiplier effect.
C’mon, they’ve whipped that one out enough. You’ve just got to beat ’em over the head with it if you get a chance.
If this were a football game, AP Lerner won 77-3.
Talk about inflation!
Really? RG and I are still waiting for him to explain how repealing taxes would be inflationary.
Lower taxes, higher private sector income, higher aggregate demad. Inflation
Higher taxes, lower private sector income, lower aggregate demand. Deflation.
Money supply increases = inflation; Money supply reductions = deflation; Lerners definitions = gibberish
Hey, here’s what happens when I myopically ignore private sector spending in the same way that you ignore public sector spending:
Higher taxes, higher public sector income, higher aggregate demad. Inflation.
Lower taxes, lower public sector income, lower aggregate demand. Deflation.
lol, my thoughts exactly!
Well, that’s just like, your opinion, man.
He’s out of his element.
Murphy is obviously afraid of debating AP Lerner. Just look at the way he ignores all of his posts. Mr big time Austrian economist thinks is he’s too good to acknowledge little old AP Lerner and his obscure Modern Monetary Theory economics. The fame of being linked to Slate and CNBC has gotten to his head. We’re going to need to start a donation drive to shame Murphy into debating him.
really? 77-3!?!
AP has yet to explain how increasing a bank’s cash reserves by moving the govt’s t-bond liability from one entity another one, Enron style, is really not an increase.
The whole QE process evades the fact that the t-bonds it is purportedly now “buying” back were previosly “sold” to all of those firms for cash which, so long as the govt is operating on a deficit, was spent to fincance govt operations so it cannot be anything but inflationary to then “buy” back those same t-bonds with money it does not have.
“AP has yet to explain how increasing a bank’s cash reserves by moving the govt’s t-bond liability from one entity another one, Enron style, is really not an increase.”
Not Enron style. It’s called reserve accounting.
“it cannot be anything but inflationary to then “buy” back those same t-bonds with money it does not have.”
History, and time, show I am correct.
Time…now there’s a rare word used by a Keynesian. Unfortunately, it’s used here in a failed attempt at redundancy (history has little to do with the passage of time) instead of the economic preference relation.
History is a personal account of a specified period. I’m guessing your referenced accounts are way different than mine and partial to successes of central planning like the Great Depression.
Although Keynesians discard time as a component of economics, it is, in fact the core concept: do I save or consume now?
Talk about your multipliers/upper bound/fiat…zing!
Here’s a clear explanation of what QE2 is all about:
http://www.myvido1.com/QY5FDVhBTTy0kVsZlVGFUP_quantitative-easing-explained
” So what would Krugman et al. predict would happen in my scenario? That the official unemployment rate would drop to 0%, and then it would shoot back up to 9% or whatever in one year’s time?”
Yes, probably… which is why he thinks that a monetary stimulus would have to be of the order of $8-$10 trillion to have a chance of working!
” To the extent that an actual Keynesian agrees with me that this prediction is ridiculous–that surely we couldn’t literally put every single person back to work for a full year, without that nudging the economy out of its pure Aggregate-Demand-slump–then can we all agree that the Fed’s current QE2 is a ridiculous failure?”
No, not really.
The crux of the Keynesian argument (which happens to be right, I believe) is that a monetary stimulus is not equivalent to a Keynesian stimulus.
When the Fed prints $600 billion of money, it goes into bank reserves and is hence, unlikely to go out into the economy immediately to start chasing goods and/or potential employees.
If it prints $600 billion and uses that to hire people directly, that would be a fiscal stimulus (which the Government can enact but the Fed can’t)
Krugman clearly showed that monetary stimulus and consequently a rising monetary base did not lead to rising broader monetary aggregates for many, many years during the depression. (as well as during the Japanese lost decade) The money just sat there in bank reserves for years!
Please brush up on the difference between monetary and fiscal stimulus when you debate Krugman. We don’t want him claiming victory on the grounds that you don’t understand the difference or don’t consider it to be important enough to study !!
If monetarys stimulus “tends to sit in bank reserves for years”, does not lead to rising prices or wages and does not lead to “broader monetary aggregates” then, by Keynsian standards, what is the actual purpose of QE?????
Ok, Ill answer my own question: to bail out the banks, no more and no less. all the rest is just fluff.
“Ok, Ill answer my own question: to bail out the banks, no more and no less. all the rest is just fluff.”
Agreed. It’s just another bank bail out. But inflationary, it is not.
I beg to differ. In the myopic Keynsian world of selective addition where bank reserves are created out of thin air and govt liabilites are held in a black hole called the fed it most assuredly creates inflation.
The Keynesians believe that broader monetary aggregates generally do rise, but NOT in the rare cases when we are in a “liquidity trap”.
And the data seems to suggest that they are right.
I think Dr. Murphy does know the difference between monetary and fiscal stimulus – that is the basis of his question. If instead of printing up the money and giving it to the banks in exchange for debt, what would happen if Ben printed up the money and used it to hire people to perform odd jobs? That is a ‘fiscal’ stimulus, is it not?
Yes, but Bernanke doesn’t have the authority to do that….. only Congress does.
So, if this monetary stimulus fails, it is not a sufficient condition to prove that an equally big fiscal stimulus would also have failed…..
“Yes, but Bernanke doesn’t have the authority to do that….. only Congress does.”
Yes, – it’s a ‘thought experiment’ meant to analyze QE2.
My opinion – he’s asking if it were a fiscal stimulus, wouldn’t Keynesians agree that it wouldn’t bring lasting full employment? If that is the case, then the how can one say QE2, a monetary stimulus, might “help a little”? Shouldn’t one call it a failure?
He is not claiming that if QE2 fails, this proves that a fiscal stimulus would also. He’s asking if QE2 were a fiscal stimulus, and you agreed it would not bring full employment, then how can you claim QE2, a monetary stimulus, might help a little?
Well, they DO believe that a large enough fiscal stimulus would lead to lasting full employment.
Atleast Krugman does.
WW2 according to Krugman was (finally) a stimulus big enough to get the world out of the depression.
They say that QE2 wont help as much as an equally big fiscal stimulus because it won’t all go into the “real economy”
“Krugman clearly showed that monetary stimulus and consequently a rising monetary base did not lead to rising broader monetary aggregates for many, many years during the depression.”
Translation: Krugman wrote an equation that showed changes in variable A and variable B did not cause variable X to change.
Instruments like these fail to consider the infinite other variables that cannot be calculated. They are as simple and blunt as the minds that created them.
I agree.
However, he is right about the narrow point that rising bank reserves don’t necessarily imply a general rise in the price of consumer goods….. (which in Keynesian theory is necessary to bring down unemployment)
Unfortunately, the mainstream macro-extremists don’t seem to care about any variable except the rate of change of CPI and the U2 unemployment rate.
So, we must be ready to answer questions on these things in a debate.
CPI and U2 are completely useless data derived from an insignificant amount of variables. Instead of trying to play their game, I believe it’s more important to expose the swiss cheese nature of their incompetent models.
This should be considered a qualification, in the sense that if the money is kept out of circulation (as excess reserves) then the real economy won’t be affected. Austrians wouldn’t disagree with this principle; what they disagree with is how the real economy will be affected once the money enters circulation (i.e. this is what Hayek was attempting to show in his lecture series Prices & Production [capital theory has progressed since then, but the basic purpose remains the same]).
By the way Yogi, you may be interested in the following article: Krugman contra Hayek.
“This should be considered a qualification, in the sense that if the money is kept out of circulation (as excess reserves) then the real economy won’t be affected. Austrians wouldn’t disagree with this principle; what they disagree with is how the real economy will be affected once the money enters circulation”
That is the crux of the debate in mainstream economics !
The Keynesians say (and they are probably right) that this money won’t enter the real economy for many years when there is a “liquidity trap”.
They do not even think of what will happen when the money does actually enter the system. It is dismissed by saying “In the long run, we are all dead”.
They think that Bernanke will somehow be able to get all the money out of the system when required!
That is an excellent article! I hope you are helping Murphy prepare for his debate 🙂
AP Lerner claims that cash is a liability of the US government. False, it isn’t. It is a liability of the Federal Reserve. If you walk with some of those notes and ask for your liability to be settled you get the same thing back that you asked for.
AP Lerner claims that bills and bonds is a liability of the US government. True, it is. It is a liability that will ultimately be settled with liabilities of the Federal Reserve.
One item (cash) can be used to exchange items on the free market , while the other is not legal tender.
In reality cash is an immediate claim on the US market place, while a bill or a bond is a claim against the US government.
So, creating more of cash in the form of reserves is somehow completely a non-event, despite the fact that you are suddenly walking into the bill and bond market with newly created reserves and can then bid as you please in a way previous market participants could not. Somehow this is not something new?
So here I am sitting with a claim (a bill) that is due 2 year from now and I am getting concerned that the value of the future dollar is going to be less than what it is now, so I offer to sell it. Because the Federal Reserve is bidding with new reserves, I get a better price than I perhaps otherwise would be inclined to get. When I get that settled I have new reserve cash which goes into my checking account. I can spend it immediately rather than wait 2 years for a meager return on it.
If the Federal Reserve had not bought my bill someone else would have traded their cash for my bill and it would be exactly as you would have it, a completely neutral transaction. Nothing new created nothing old lost.
“It is simply an asset swap: swapping a non interest bearing note with a slightly less liquid, interest bearing one.”
Slightly less liquid? Cash is MUCH more liquid than government bonds. Let me know when government bonds become legal tender, or when you can go to the store and buy something with your t-bill.
By giving the $600 billion to make workers you could not ensure that the money would go into the areas of the economy that need the most stimulation.
Some quick reactions to all this stuff:
(1) Reserves and Treasuries are not the same thing. I think Wenzel adequately explained why.
(2) Suppose Bernanke (in conjunction with the Bureau of Printing?) literally printed up $600 billion in new currency, then entered the bond market and bought T-securities with it. AP Lerner, would you still look at the fresh $100s coming off the printing press, and say, “No new money is being created?” You can still say, “This won’t be price-inflationary, because the demand to hold base money rises to exactly offset the injections of new base money,” but I think you should stop denying that QE creates new money. It does.
(3) I understand the difference between fiscal and monetary stimulus. But, I could say the same thing if we were talking about a fiscal stimulus. Back when the Obama Administration ran the first stimulus, if you had divided the total amount by the number of unemployed people at that moment, it would have been a huge $$ amount per person. So I could have asked Krugman at that time, “You agree if the gov’t directly employed all these people, that the unemployment rate would fall to 0% immediately, right?” And then I would have liked to hear him reconcile that with his models.
“You agree if the gov’t directly employed all these people, that the unemployment rate would fall to 0% immediately, right?”
He would have said “NO”…..
The way it works in Krugman’s ideal universe is:
1) Government forcibly brings about full employment and keeps it there for some time (Eg: By drafting people and thrusting them into a slaughterhouse in Europe)
2) This causes price inflation (Eg: Prices went up substantially during WW2)
3) Consumers and firms who were “balance sheet constrained” due to very high levels of debt see their net worth rise as the debt is inflated away. Debt as a percentage of GDP goes down to “manageable” levels. (Eg: http://krugman.blogs.nytimes.com/2010/10/25/a-far-away-country-of-which-we-know-nothing/)
4) The consumers and firms start spending and investing again. ( Which is what caused post war recovery according to Krugman)
Naturally this takes some time (4 years in the case of WW2)
So, if you ask Krugman how much needs to be borrowed and spent, he will probably calculate the amount needed to employ all the unemployed for a year and multiply by that 4 or 5.
It will be in the neighborhood of $4-$5 trillion.
“Reserves and Treasuries are not the same thing”
– correct, commercial bank reserves are either a type of collateral for “money” or the potential to be such. Either way they are not fungible with treasuries; treasuries are a claim on the tax revenues of the U.S. , cash or bank deposits are unclaimable claims on the federal government (via the fed or FDIC), essentially token money.
“Suppose Bernanke (in conjunction with the Bureau of Printing?) literally printed up $600 billion in new currency, then entered the bond market and bought T-securities with it.”
– Even if they didn’t print the new cash in the from of paper notes, through a QE transaction the fed is debiting the sellers acount, a bank deposit and the corresponding reserves are then created. The bank deposit is spendable money (of course that doesn’t mean it will be spent). But does this portion of the money that will be spent or re-invested in riskier assets and/or projects fill the gap left by the “liiquidity trap” or the “deflationary psychology” or whatever you want to call it? The question is whether this ballooning of reserves will lead to banks expanding credit. No it won’t, that requires demand for credit. Where do you see that? Real rates would have to plunge, or be expected to, for that to happen – or the economy would have to expand rapidly.
Obviously, it’s essential that all such “stimulus” must first go through all of the appropriate “legal” channels in order to effectuate its intended basic purpose.
I have to take this in a different direction. I don’t think QE2 is as much about employment or core inflation as it is about housing prices. I made that observation on my blog last week, and it was seconded by Andy Kessler in the Wall Street Journal today. QE2 is essentially TARP 2, and any effect on employment will be conicidental.
When the Fed switched from using the PCE deflator (which shows inflation in the Fed’s target range) to the CPI, which gives housing double the weight of the PCE deflator, Bernanke tipped his hand that he is critically concerned about the toxic asset problem rearing its ugly head again.
so does that mean that you think that t-bonds are “troubled assets” that the fed needs to remove from the private sector or do you mean that they will pull another switch and buy RMBS/CMBS instead of t-bonds as was originally announced?
Also, how will QE2 help housing prices as the banks are not really lending and are actually raising the lending standards for FHA borrowers?
No, t-bonds aren’t toxic assets, at least not yet, and FHA standards are out of the Fed’s control. But the Fed’s express purpose of QE2 is to elevate inflation above current levels, and by using a metric that is more housing-heavy, the Fed tipped its hand that it’s focusing on housing prices.
Now whether the dollars from the “pump priming” find their way into the housing market remains to be seen – they may just find their way into autos, clothing and commodities. But it would be politically and psychologically difficult for the Fed to tackle the housing market and the balance sheet of banks directly; more or less an admission of the inadequacy of other efforts to put a floor under housing prices.
If the housing market does continue to fall, I won’t be surprised if the Fed goes back to dabbling in real estate. For now, though, I think Bernanke & Co. are going to try a crude monetary club to beat the housing demon, especially since there’s little else they can do with interest rates. I’m not saying it’s a good plan, but if you take housing out of the equation, QE2 is unnecessary on inflation grounds.
AP Lerner,
if it was merly a swap of identical assets, why do they even need the FED to step in? Why can’t they sell the treasuries on the free market? Well, they couldn’t. It it wasn’t for the FED, those treasuries were trading at completely different interest rates which would reveal the real risk. Fewer people would be willing to buy treasuries and both the treasury itself and the banks holding all these assets in their ballance sheet would have a hard time selling them. So the real value of those assets as determined by the free market would be far less than what the FED is now paying for them. The FED if basically overpaying and thereby increasing the money supply by the amount that they are overpaying. And the fact that everybody expects the FED to keep overpaying even in the future keeps prices up and interest rates low. It’s the same scheme over and over again.
Just imagine the FED was buying up subprime mortgages the way they are buying treasuries now. Would you still say that wouldn’t increase the money supply because the mortgage would magically disappear in the FED’s ballance sheet? After all, a mortgage is just an even less liquid asset class which is replaced by a more liquid asset class, right?