Monday, September 26, 2011

Enough with calling for more Fed action already

Operation Twist. There goes the Fed again with its endless bag of tricks. QE2 did not work as expected. Now they hope the Twist will do the job. The ironic thing is that for the past two years, Bernanke himself has been saying that the government needs to undertake more fiscal policy. Read between the lines, and you'll see that he is already very reluctant to do more on the monetary policy front as it just introduces more complications to an already fragile economy, leads to more malinvestment, more market uncertainty, without really achieving its real aim, which is to encourage more economic activity in the economy. At this point, the fed is doing the Twist likely only to promote the perception that the fed is doing something.

Monetary easing is a potent economic weapon, and just like an atom bomb, it doesn’t make a distinction of who its target is. It doesn’t care whether you’re rich or poor, whether you’re a consummate saver or you’re a consummate debtor. Monetary easing will always have one effect on you – take on more risk. Many monetarists who subscribe to the beneficial effect of monetary easing are blindsided by the debt problem. Many people who subscribe to monetarism don’t believe in the existence of banks or debt, and think that increasing the money supply automatically results in a higher price level. Those that do believe in the existence of banks think that banks automatically lend what funds land on their laps without consequence. And that they can just find additional capable borrowers out on the street like Mcdonalds finds new patrons for new stores.

Monetarist proposals ignore Debt's downside effects on economic agents, while over-estimating easing's effects on inflation expectations. But debt does make a difference -a very large difference. Inflationary measures can be hindered in a recession economy with a lot of debt, because the indebted that are undergoing deflation, i.e. balance sheet recession, will not be induced to make more purchases if paying off the debt is already eating up much of their income. Monetarists hope that the non-indebted ones will come to the economy's rescue, and be induced to consume more, because of increased inflation expectations (they will consume now before prices get more expensive). But then, the non-indebted have to first be convinced that the ongoing balance sheet recession among the indebted will not counteract any of the inflationary measures. Thus far, nobody's convinced. Not in numbers big enough to achieve what monetarists want. The question is, should the Fed be ready to do whatever is necessary to move everyone's expectations? What are the unintended consequences of printing whatever it takes to move everyone's expectations? (Of course I say no, and have said so here, here, and here).

Indeed, Fed policy has come down to managing expectations. And it’s all about the expectation that everyone’s expectations will be as the monetarists expected (pun intended). Just like people who try to drive their cars by only looking at their rear view mirror, monetarists believe that the Fed can run the economy by looking at the stock/asset markets. Yet the monetarist view is so widely held by many economists that several have proposed changing the Fed's charter and increasing the Fed's powers to be able to invest not just in governments bonds, but also in private sector corporate bonds and equities. All this talk of the Fed using unconventional monetary policy tools has had the effect of making many economists propose even more far out Fed actions than its charter already allows.

But is this a good idea? Should government be allowed to buy corporate stocks and bonds? Assuming that central bankers are allowed to buy stocks, why consider only select companies in the S&P? Why create an uneven playing field by giving these already large publicly-listed companies a lower cost of capital over other companies? Why not issue new money to fund new ventures instead? After all, small businesses not listed in the stock market probably have better prospects for growing the economy, and returning better yields to government, no? And if these small businesses fail, the act still boosted money supply going around in the system, which is the intention (of this proposal) anyway. Government getting into the public stock market only rigs the stock investing game more than it already is.

Throughout its existence, the Fed has had an escalating mission creep. It started with merely being the lender of last resort, to help banks undergoing liquidity problems. Then it was given the dual mandate of price stability and controlling unemployment. It therefore now uses its rate-setting power to control economy-wide inflation, control aggregate employment, control system-wide bank lending, and control over-all asset speculation. As a secondary effect, its power has had control of the stock and bond markets, and therefore it has control of industrial policy.

The Fed has control of the currency's value, and as the issuer of the global default currency, therefore controls international capital flows and international trade flows. It therefore has indirect control of foreign countries' monetary policy, and therefore indirectly controls foreign inflation, controls foreign stock and bond markets, controls foreign industrial policy and other countries' experience of international flows. If we increase the scope of its mandate, who knows what secondary effects are next?

If we allow the Fed to invest in corporate bonds and equities, where does Fed intervention end? If the Fed's charter is further increased, the Fed may just as well dictate who people marry, and how many children they sire. After all, these decisions have economic repercussions, right? Allowing more kids is easing, restricting having them is tightening. Is this where all this is heading?


Ellen1910 said...

My view, since early 2009, has been that the Treasury should simply send out a trillion or so dollars to American households and continue doing it yearly until the economy recovers.

And there's no reason whatever that the Treasury should borrow before, after, or ever to "pay" for the program. Just write the checks.

Ellen1910 said...

I don't understand why monetarists think that the Fed's buying assets (and I'm assuming buying assets from non-banking economic actors) increases either economic activity or beneficial inflation.*

Yes, the Fed "prints" money with which to make its purchases. And yes, for a few days or weeks the sellers' deposit accounts (M0, MZM) are showing an increase. But these sellers are savers/investors; they'll simply use the sales proceeds to buy other assets to replace those they sold to the Fed.

Yes, the money keeps circulating from one seller's checking/money market account to the account of the next seller (thus, technically/definitionally the money supply has been increased), but it all circulates within the investment community. The only effect is an increase in asset prices.*

* I suppose that the additional money has the potential of increasing certain costs to consumers (e.g., if used to bid up oil futures or to hoard the oil itself gas prices rise). That increase will show up in the cost of living, but I hardly think monetarists believe whacking the consumer is a good idea.

So what do monetarists think is the benefit in having the Fed buy investment assets from investors.

Tom Hickey said...

I fail to see how anyone, left, right or center, can think that having a small group of interested, unelected, and unaccountable, "politically independent" technocrats managing monetary policy is a good idea. It is fundamentally anti-democratic and anti-capitalistic — basically a command system.

Rogue Economist said...

Tom, I'm also wondering why many so-called free market thinkers are monetarists. Just because monetarism enables certain capitalists to make money regardless of what happens to the real economy doesn't mean monetary policy assists in attaining a really free market.

Ellen, finally we see agreement that borrowing prior to government spending is non-essential. But I have to ask what factors led you to the trillion dollar payout to households.

That seems greatly excessive. And I have strong doubts that pure handouts lead to economic recovery. What is needed is job creation, and productive jobs at that.

The Arthurian said...

Tom, this is me sticking my tongue out at you for saying what you said. BTW I am apolitical, thus neither left nor right nor center. The problem is in the money, Tom.

Ellen: "Yes, the money keeps circulating from one seller's checking/money market account to the account of the next seller (thus, technically/definitionally the money supply has been increased), but it all circulates within the investment community. The only effect is an increase in asset prices." Yes yes yes yes yes.

Rogue, I would take Ellen's trillions and use them to pay off private-sector debt for people, so that their normal incomes would be freed up for normal spending. And that's how to get economic recovery.

You said "Monetarist proposals ignore Debt's downside effects" and other neat stuff about debt, but then you lost focus on debt, too.


Rogue Economist said...

Arthurian, let's put this idea into a thought experiment. Trillion dollars gets divided into a population of a million households, so each gets a million each.

Half of the million households is underwater by a million, but the other half are not indebted. After the million giveaway, everyone is a million dollars wealthier in nominal terms. Those in debt now have multimillion dollar valued homes free and clear, and own at the previously high values (since not one had to be foreclosed at firesale prices).

The ones without debt now have million dollars to spend, and since productive capacity did not increase, will now start bidding up all goods and services. The most scarce commodities go up the most. Food prices go up as well. People immediately run down the million dollars because of the higher prices for basic necessities, especially the scarcest ones like oil.

Perhaps those who were never in debt before now begin to think they can go into debt buying up one of the multimillion dollar homes. If this scenario happens, we'll now have inflation, and we're right back to people with heavy debt. Not all the money was spent into building new businesses, because since the payout rewarded those who speculated on asset prices the most, this serves as an example to everyone that speculation pays. Also, the higher basic goods prices ensures there is much less available for new ventures.

So tell me, how is a trillion dollar printing to basically just distribute to everyone for nothing in return better than a trillion dollars used to fund an actual new venture that hires the same people to add to capacity?

And how did I lose focus on debt with this scenario?

Ellen1910 said...

Sometimes RE a difference in degree -- ($6-15K to each of 105 million American families) v. ($1M to each of 1 million Martian families) -- really is a difference in kind -- or, you're a looney.

Back to the real world. I agree with you that an increased supply of money will lead to increased demand -- exactly what we're looking for. There may be some demand-pull inflation, but with the amount of slack in the economy, not a whole lot.

I, also, agree with you that a good portion of the distribution would go toward balance sheet repair -- that is, the increase in the money supply (even counting a multiplier effect) would probably not reach $1.2 trillion, annually.

Nevertheless, giving the people the money and letting them decide what to do with it rather than giving play money to the elites warms my populist heart.*

* If I were queen I'd raise the amount, drop the EITC, and make the distribution taxable to retain a certain progressivity.

Rogue Economist said...

Ellen, over in Mars we need our aggregates broken down so we know exactly what is being proposed. Too many dubious proposals have been seriously considered because they weren't broken down into their basic assumptions to reveal their flaw. $6-15K per household doesn't seem as excessive.

I would still maintain though that to the 30 million unemployed, being given a job is better than a onetime $6 or 15k. But that's just me. We martians like our income to be recurring.

Ellen1910 said...

The government can't (not politically is unwilling to but can't) give 30 million un- and underemployed and discouraged workers a job.

It can pay to put federal and state and local workers back on the payroll; it can even increase the size of those payrolls, modestly; it can pay for "shovel ready" projects. In the end though it can't make much of a dent.

That leaves the private sector to be the job machine, but firms will only hire when demand for their products rises.

This isn't 1933, and we don't require a WPA or a CCC. Then, the consumer side of the non-farm economy was modest. Today, consumers buy 70% of the economy's output.

Give consumers the money* and they'll take care of the rest.

* Actually, "give" isn't the best word, since consumers (the donees) are also citizens (the donors). And in a democracy those citizens have the perfect right to give themselves the money. It's their money, in the first place, isn't it?

Rogue Economist said...

I have repeatedly said that government couldn't employ everyone who needs job, and we would need support for private initiatives. But if you can see benefits in giving away $6-15K to everyone to spend as they wish, I see benefits in using this money to beef up agencies where they are currently wanting for manpower. Private sector efficiency is also affected if the public sector is not up to par because of budget cuts.

Ellen1910 said...

To Calgacus: I'm moving my response to this thread as a matter of housekeeping and because RE's criticism of the expectations of orthodox monetarists -- vis-a-vis the effects of extending QE purchases to nontraditional assets -- seems applicable to our argument/discussion.

Inflation is always and everywhere a monetary phenomenon. —Milton Friedman

1) Do MMTers agree, and if so,
2) How do MMTers define "money" which must be done before a discussion of Friedman's claim -- based as it is on the meaning of "monetary" -- can begin.

N.B. Hopefully, we can have the discussion without the words "bank reserves" coming up since I believe we all agree that reserves are merely accounting entries in our current practice of settlement between banks, aren't actually necessary or required for settlement or anything else, and aren't "money."

Rogue Economist said...

Ellen, I'm hardly one of the intellectual leaders of the MMT, though I would claim to be influenced by it. Hopefully, Scott Fulwiller would chime into the discussion at some point. Here's a post from NEP that might give you an idea how they would define it.

As for my own interpretation, as I said in the other thread, Money is a token that can equate to the value of a good or service you provide, that you can then use to purchase something else of equal value. I buy into the idea that its value as a token is greatly assisted by government fiat. If it's privately-issued, it can easily lose its acceptability as a token of value.

As for the Friedman quote, I think inflation is a phenomenon caused by more demand than supply for a certain or all goods. I believe nominal inflation can be greatly caused by the amount of money in the system because everything is bought with money. But for the most part, there should be increasing demand for the thing being bought over its supply.

Ellen1910 said...

I'm interested in MMT's definition of "money" primarily because I want to be able to identify, among other things, 1) the "money" supply at some time (t0) and 2) the change in the "money" supply from/to another time (t-1, t+1).

Those numbers are required to check Friedman's claim as against history. They are, also, required to show the effects on the "money" supply of actions taken by the Fed and the Treasury.

Stocks (money supply) and flows (circulation). Stocks and flows -- my head is going to explode.

Quaere: Which of the Ms does MMT prefer/emphasize?

Rogue Economist said...

The only one I've seen using M is Pragcap.

I think it depends on the specific circumstance whether Friedman is correct or not. Perhaps when he said it, increasing the money supply increased inflation. I think he said that prior to the 1971 abandonment if the gold-dollar peg. This was also a time when lending was still growing.

Now we are in balance sheet recession, and banks are reluctant to lend, even though the fed stands ready to lend banks all the reserves they need, and has already exchanged their treasury holdings for reserves. Right now, you can no longer say that increasing the money supply will increase inflation, at least if by money supply you mean reserves. But if they increase it via helicopter money like your favoured proposal of money for all households, that would be different.