Will it work?

The short answer is “I don’t know.”  But I presume you’d like a bit more analysis.  So here’s the best I can do. 

There are three questions embedded in the simple phrase ‘will it work?’

1.  Will it help the economy relative to the no-QE alternative?

2.  Is the announced policy likely to help more than the policy expected right before the announcement?

3.  Is it adequate to meet the Fed’s implicit policy goals?

I believe the answer to the first question is clearly yes, the second question is “probably yes,” and the answer to the third question is clearly no.

It’s pretty obvious that the stock, bond and foreign exchange markets responded strongly to rumors of Fed easing over the past 6 weeks.  So let’s focus on the next question, how did the markets respond to the 2:15pm announcement? 

When the announcement is a big surprise, it is easy to infer the market response.  In this case the policy was close to expectations, yet the various market responses suggest the move was slightly more expansionary than expected.  Let’s start with the T-bond market, where I collected bond yield data at 2:00pm and 3:30pm: 

Maturity    2:00 yield        3:30 yield

3 month        0.12                   0.12

1 year           0.20                   0.20

3 year           0.49                   0.47

5 year          1.15                    1.11

7 year          1.84                    1.85

10 year        2.53                    2.62

30 year        3.87                    4.07

The longer term bond yields clearly rose, which could indicate either a expansionary or a contractionary surprise, depending on whether the liquidity or the Fisher effect was dominant.  Because the Fisher effect is more powerful at longer maturities, it was probably an expansionary surprise.  Further evidence comes from the 3 to 7 year maturities, where yields actually fell slightly (presumably due to the liquidity effect.)  I don’t know why T-bill yields were unchanged; perhaps interest on reserves puts a floor on the very short term rates.  Now let’s look at the response in the TIPS market:

Maturity    2.00pm     3:30pm

5 year         -0.46        -0.54

10 year        0.40         0.44

30 year        1.30         1.42

And the TIPS spreads (inflation expectations):

Maturity    2.00pm     3:30pm

5 year          1.61          1.65

10 year        2.13          2.18

30 year        2.57          2.65

This points to slightly higher inflation expectations, which is also consistent with the view that the policy was a bit easier than expected.  I’m not sure why real rates rose over longer maturities—perhaps it reflected the expectation that the economy would recover slightly more rapidly, and thus real rates would return to normal at a slightly faster pace.  That was the thesis in my recent post about why a little bit of inflation might actually help savers. (Not quite so far-fetched as many assumed.)  On the other hand, the 5 year bond shows clear signs of a liquidity effect, even for real rates.  But in a way this is good, as it suggests that we can be confident that the fall in the 5 year nominal yield reflected monetary ease, not lower inflation expectations.

The foreign exchange markets tell a similar story:

Currency    2:00pm      3:30pm

euro             1.401       1.4105   (euro appreciates)

yen              81.375      81.275   (yen appreciates)

pound          1.6075     1.6085    (pound appreciates)

The dollar fell significantly against the euro, and slightly against the other two (note the yen rate is reported “backwards.”)

Unfortunately, the stock market was a complete mess.  This is no surprise, as the market often gyrates wildly when the “news” is not a single number, but a report full of nuance that must be digested by experts.  In the end, stocks rose slightly from pre-announcement levels, but nothing statistically significant.

I was hoping for something much more shocking, so that we could really sink our teeth into the market responses.  Unfortunately (as with the election) the pundits had already provided fairly accurate predictions, taking all the fun out of the actual event.

In the end, the market movements over the last few weeks seem to be telling us that QE2 is likely to provide a modest boost to the economy, and that a double dip recession is less likely than in August.  But overall the future still looks bleak.  The Fed’s action fell pitifully short of what was needed.  At a minimum, I would have liked to have seen enough stimulus to raise 5 year TIPS spreads to 2.0%, instead they merely rose from 1.61% to 1.65%.  We didn’t need more QE, but rather the three-pronged attack I suggested earlier (including lower IOR and level targeting.)

Of course markets are often wrong, and the economy may do better than expected or worse than expected.  But for those of us who favor a Svenssonian policy of targeting the forecast, the verdict is already in; the policy is better than nothing, but not nearly enough.  My hunch is that unemployment will remain high for quite some time, and the Fed will be forced to do even more in 2011.  Of course this is a policy that should have been adopted in 2008, when it was already clear that AD would fall far short of the Fed’s implicit goals.

A few months ago I listed the March 2009 market response to QE1 as one of things I had been wrong about.  I could not explain why the announcement reduced long term bond yields.  At least this time the bond market responded in the “correct” fashion.  I thank all the bond traders for not humiliating me a second straight time.  Perhaps they have begun reading TheMoneyIllusion.com, and learned that stimulus should make long term bond yields increase.  :)


Tags:

 
 
 

65 Responses to “Will it work?”

  1. Gravatar of Contemplationist Contemplationist
    3. November 2010 at 14:49

    Scott

    I’ve been turned from a quasi-Austrian explanation to your quasi-Monetarist one. One of my doubts though is about rational expectations. Yeah we know that due to sticky wages, the older employment contracts in 2008 resulted in lots of job losses due to loss of AD. But now that we are “expecting a new normal” why should high unemployment persist due to sticky wages? shouldn’t this be enough time for wages to adjust to at least significantly reduce the unemployment rate? What am I missing?

  2. Gravatar of scott sumner scott sumner
    3. November 2010 at 14:57

    Contemplationist, That’s a good question. We know that nominal wages have not adjusted enough to provide full employment, given that NGDP grew 9% less than trend, but we don’t know why. I’ll throw out one theory:

    In most past recessions the NGDP recovery has been much more robust. So workers take a modest pay cut, assuming that they’ll be bailed out by fast rising NGDP during the recovery. For instance, NGDP was rising 11% during the 1983-84 recovery, vs. 4% this time. So we’ve had two unpleasant surprises, the sharp drop and the very weak recovery in NGDP. We haven’t yet adjusted to the second one.

    I also think there are some structural problems, but would insist that some of those structural problems are themselves worsened by the weak demand (99 week UI and minimum wage increases.)

    I don’t find this explanation completely satisfactory, but then in 200 years no economist has provided a completely satisfactory explanation for why labor markets adjust so slowly. I’m not going to solve that problem, I’ll just work with the stylized fact that sudden NGDP drops create high unemployment, and slow NGDP growth in recoveries is associated with slow real GDP growth in recoveries.

  3. Gravatar of David Pearson David Pearson
    3. November 2010 at 15:51

    Scott,

    The Fed today promised to do more QE “as needed”. You point out that, if they were targeting expectations, then “as needed” has immediately arrived as the 5yr TIPS spread is still around 1.6%.

    The Fed must see it differently. What is the “state contingent” variable they are looking at? Are they targeting actual inflation rather than expectations? Or do they think markets will take a while longer to correctly digest the information, such that expectations will soon rise? The latter is in direct opposition to EMH. The former leaves them vulnerable to the lagged effect of policy on inflation. The whole thing makes little sense.

    BTW, long term yields backed up for the simple reason that the Fed stated only 3% of QE2 will go to the 30yr, versus around 15% for QE1. This disappointed 30yr buyers that front-ran QE2, and they dumped their bonds as a result.

  4. Gravatar of Richard W Richard W
    3. November 2010 at 16:02

    I think you need to give it a few days before reading too much into yields. Relaxing the 35 percent per-issue limit must have some effect. Moreover, the maturity range is not always incorporated in the immediate reaction.
    http://av.r.ftdata.co.uk/files/2010/11/NYFED.png

    I agree with Krugman that the never doing enough conservative central banking approach just discredits the policy. Because it is too small they will need to come back with QE3. Then the media will be full with people assuring us that QE1 & QE2 did not work. Totally ignoring any counterfactual of where the economy would have been without the easing.

  5. Gravatar of marcus nunes marcus nunes
    3. November 2010 at 16:06

    Scott
    You were much “too kind”. In the end only your point #3 is relevant. Because of all the recent talk of some “target” being chosen (PLT was not discarded), I think what was decided came short of expectations (although “something” is viewed as better than “nothing”).I still think the Fed did a “Rhett Butler”: “I don´t give a damn, my dear.

  6. Gravatar of Shane Shane
    3. November 2010 at 16:51

    I’m sure this is stupid for a really good reason (I’m not an economist), but I’m genuinely really interested in the reason:

    This blog post reminds me of the Steven Wright quip “Why don’t they make the whole plane out of that black box stuff?”

    That is, if monetary stimulus is so awesome and so much better than fiscal stimulus, why not just make all government expenditures monetary policy? Surely an inflation targeting central bank could neutralize the inflationary effects of this, no? Plus it sounds really cool to have no taxes: we could also abolish tax lawyers and accountants completely, freeing up those resources for other things.

    But then the problem would be: how to conduct monetary policy? You could use corporate debt, but isn’t one kind too unlike all the other kinds to be a reliable way of setting prices generally? One corporate bond does not necessarily effect the prices of the other bonds as with treasuries; and ditto for other financial assets and for assets generally–buying a lot of platinum doesn’t necessarily raise the price of raisins, and it might have other erratic effects on industries that use that commodity.

    All treasuries, however, are alike more or less, so the problem does not hold–buying any 30 year treasury is like buying any other one. So setting the price of government lending is a really convenient way to conduct monetary policy and avoids the undesirable effects of dealing in other types of assets.

    But in order to be able to tighten or ease, there has to be treasuries to buy or sell, so at some point there had to be fiscal stimulus, i.e., there had to be deficit spending. So if fiscal stimulus doesn’t exist, doesn’t monetarism need to invent it?

    It would be pretty cool to eliminate accountants though.

  7. Gravatar of marcus nunes marcus nunes
    3. November 2010 at 17:08

    I reread the post. It´s worse. I came out “peeved”! You start with “I don´t know”, almost as if you´ve given up the “fight”. Bernanke is hopeless. Nothing and no one will be able to convince him that he (the FOMC, but he´s the “boss”)is fully responsible for the big NGDP drop (the first since 1938). I know that to “destroy” is much easier than to “build”, but he could at least give it an honest try! My prediction: unemployment is likely to rise and inflation stay low (or even fall somewhat). After all, nothing has happened to correct the monetary disequilibrium in place.

  8. Gravatar of Randall Randall
    3. November 2010 at 17:09

    Scott,
    What prevents this new QE round from being absorbed into the carry trade and out of the US?

  9. Gravatar of Matpw Matpw
    3. November 2010 at 17:17

    How do you respond to the following argument:

    “In and of itself, QE did nothing but to provoke a decline in monetary velocity proportional to the expansion in the monetary base, with little effect on either real GDP or inflation. When QE was pursued in Japan, it did nothing but to provoke a decline in monetary velocity proportional to the expansion in the monetary base, with little effect on either real GDP or inflation. In our view, an additional round of quantitative easing will do nothing but to provoke a decline in monetary velocity proportional to the expansion in the monetary base, with little effect on either real GDP or inflation.”

    Source: http://www.hussmanfunds.com/wmc/wmc101101.htm

    Could QE be a zero sum game? Thanks!

  10. Gravatar of JTapp JTapp
    3. November 2010 at 17:18

    I just read somewhere that the FDIC charges most banks 30 basis points on their deposits. If the Fed is paying less than that on reserves, isn’t the IOR relatively moot anyway?

  11. Gravatar of MBP MBP
    3. November 2010 at 17:30

    Scott — On the rise in yields of 10-yr’s and 30-yr’s vs the fall in yields for 5-yr’s. The FOMC announcement said that the average duration of the purchases would be 5-6 years. My (mostly uninformed) opinion is that the market may have been expecting more purchases of 10-yrs and 30-yrs.

    While this is open to interpretation it might explain the more muted stock market reaction. Wouldn’t purchases of longer maturity bonds have had a greater impact? So i guess i fall in the camp of “slight disappointment” vs. expectations.

  12. Gravatar of christopher mahoney christopher mahoney
    3. November 2010 at 17:32

    Scott:
    I have been trying to discover the legislative language behind the “dual mandate”. Is it a “please try” mandate, or a “do it” mandate? The FOMC statement today was aspirational, “help ensure maximum employment ” as opposed to “will ensure”. Does the law allow the Fed to “try” to ensure maximum employment, or is it stronger?

  13. Gravatar of Benjamin Cole Benjamin Cole
    3. November 2010 at 17:34

    Another superb post by Scott Sumner. Yes, I want a more-agressive Fed too. Inflation is dead. I agree with Sumner on the IOR and other issues.

    But! We’ve come a long way baby. This is unconventional policy in a supremely conventional town. If the Fed buys $75 b. and also keeps up its mortgage purchases, we see than $100 b. a month in QE.

    I still think a national lottery that pays out $2 for every $1 collected, in $100 billion a month of $1000 winning lottery tickets is a better idea, but that idea is not practical. (This would put money into the middle class, or so I hope).

    The cheap dollar will help, but this recovery will take years, and then if nothing else serious goes wrong.

    I am still worried we could do a Japan, especially if property values continue to wallow. I am willing to go to 5 percent inflation, if need be.

  14. Gravatar of Jeff Jeff
    3. November 2010 at 17:40

    Scott, two comments. First, about the reaction to QE1 not being what you expected. There’s a perfectly good reason for this known to every econometrician. The data are out to get you.

    Second, with respect to your reply to Contemplationist, an even better (worse) example is Japan, where the unemployment rate peaked at 5.5 percent in mid 2003 and then took a full four years just to get down to 4 percent.

  15. Gravatar of marcus nunes marcus nunes
    3. November 2010 at 17:40

    @ Randall
    Look at this:
    http://www.voxeu.org/index.php?q=node/5740

  16. Gravatar of Manny C Manny C
    3. November 2010 at 17:41

    Looks like Dow picked up almost 100 points post qe2 announcement. so that indicates market surprised by upside. but when they had time to process the fact that rate of qe2 was less than expected, market sagged a touch.
    Here’s a good summary of mkt expectations vs. what happened:
    http://www.calculatedriskblog.com/2010/11/comments-on-fomc-statement.html

  17. Gravatar of No Stocks 4me Kramer No Stocks 4me Kramer
    3. November 2010 at 17:43

    I’d go with anything at this point that would bring back 5% on my CD’s

  18. Gravatar of Doc Merlin Doc Merlin
    3. November 2010 at 18:16

    If I recall correctly, Austrian theory suggests CPI won’t change much right away, but assets will bubble again. This is also the experience from Japan iirc, CPI didn’t change much but foreign currency rates and asset prices changed quite a bit.

    I really should go back to reading Mises’s Theory of Money and Banking. Almost every time I see something happening, it ends up looking like Mises was right.

  19. Gravatar of Morgan Warstler Morgan Warstler
    3. November 2010 at 18:37

    Well, I’m so glad that we’ve had this move by the Fed, so that now tomorrow Scott can go back to bitching about Krugman and insisting OVER and OVER that the Fed needs to do QE3.

    If eventually it comes times to stop wondering why there is wage stickiness, and start complaining OVER and OVER that the Fed isn’t forcing wages to get unsticky, be sure to let me know.

    I shall be endeavoring to actually put the hard assets into the hands of the people who deserve to own them… and ensuring that Scott never gets the truly ecstatic release he desires.

    It surely feels like it is time to Audit the Fed.

  20. Gravatar of Shane Shane
    3. November 2010 at 20:38

    I think the Tea Party victory is already making our currency more sound. Today I was able to go to this place called “the store,” where I discovered that the previously worthless dollars in my wallet were suddenly exchangeable for a large basket of commodities. Thanks Tea Party!

  21. Gravatar of Doc Merlin Doc Merlin
    3. November 2010 at 20:59

    @Morgan
    “Well, I’m so glad that we’ve had this move by the Fed, so that now tomorrow Scott can go back to bitching about Krugman and insisting OVER and OVER that the Fed needs to do QE3″

    Rofl!

    “It surely feels like it is time to Audit the Fed.”

    I agree!

  22. Gravatar of Morgan Warstler Morgan Warstler
    3. November 2010 at 23:23

    Mish nails it: Ben admits he’s targeting stock prices.

    http://globaleconomicanalysis.blogspot.com/2010/11/bernanke-admits-targeting-stock-prices.html

    Maybe we could get him on some kind of SEC violation?

  23. Gravatar of W. Peden W. Peden
    4. November 2010 at 00:35

    Doc Merlin,

    Von Mises, like Marx, is famous for having 20/20 hindsight. Of course, if you accused him of having foresight, he would have been very upset, given his aprioristic approach to economics.

    As for the Fed’s announcement, it still doesn’t solve the fundamental problem: if people don’t expect an increase in the monetary base to be permanent, they won’t behave as if the increase in the monetary base will be permanent. Insofar as people still don’t know what the Fed is going to do 12-24 months from now, this is no more than a band-aid measure.

  24. Gravatar of Mattias Mattias
    4. November 2010 at 01:32

    @Shane

    Well then maybe you’ll enjoy this litte gem

    http://www.xtranormal.com/watch/6916109/

    “I do not care, I want gold” :)

  25. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    4. November 2010 at 02:05

    30y yields – it is not clear if it is Fisher effect or a surprise that average duration of purchased bonds will be only 5-6 years.

  26. Gravatar of marcus nunes marcus nunes
    4. November 2010 at 02:25

    Sorry for the “outburst”. Maybe I had irrealistic expectations. But from this phrase in the statement: “The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability”, I wonder if “changes in the size of asset purchases” is the way MP will be conducted going forward in lieu of “changes in the FF rate”.

  27. Gravatar of James in London James in London
    4. November 2010 at 02:53

    Scott. Congratulations on achieving part of your goal.

    Although I only have PhD in early modern economic history and not monetary economics, printing money to pay for government deficits is still printing money. Dressing it up as QE doesn’t really disguise the fact. It does play havoc with bond markets, so normal bond market signals in response to such inflation are not good guides. In fact, maybe that’s part of your clever plan. Investors will remain in a quandary over how to respond, but printing money to pay for the deficits is still no way out of the problem, and won’t prompt US companies to invest their cash in the US when they have the whole world to choose from.

    The best hope that this won’t lead to more inflation is if your government becomes deadlocked, and passing new spending bills or renewing spending programmes gets too difficult. This is precisely the scenario Milton Friedman had hugely enjoyed in the past as he stated clearly in that Hoover Institution interview Morgan W posted a link to a while ago. And the only way he ever foresaw government deficits falling. Idealists like you, Scott, would not approve of his scepticism, bordering on cyncism (when it comes to our governments).

  28. Gravatar of The morning after – Economics - The morning after - Economics -
    4. November 2010 at 03:40

    [...] pundits, the question being tossed around is whether QE2 will "work". Scott Sumner helpfully breaks down what that question actually means:There are three questions embedded in the [...]

  29. Gravatar of JTapp JTapp
    4. November 2010 at 03:42

    One concern I do have with QE is that it does blow bubbles in emerging markets and put pressure on small countries to defend pegs. Maybe it blows up the “Bretton Woods II” system but that can be more painful for other countries than we might acknowledge. I assume that’s why Geithner goes to the G20 and says we’re not going to rapidly devalue the dollar.

  30. Gravatar of Some brief thoughts on QE2 « John Barrdear Some brief thoughts on QE2 « John Barrdear
    4. November 2010 at 04:04

    [...] It seems fairly clear to me that the announcement was by-and-large expected and so “priced in” (e.g. James Hamilton), but there was still something of a surprise (it was somewhat greater easing than was expected) (e.g. Scott Sumner). [...]

  31. Gravatar of Shane Shane
    4. November 2010 at 04:57

    @Mattias

    “You know you can buy more with airline miles.”

    Ha!

  32. Gravatar of JimP JimP
    4. November 2010 at 05:52

    http://barrdear.com/john/2010/11/04/some-brief-thoughts-on-qe2/

    begin quote
    By keeping IOR above the overnight rate, the Fed is sterilising their own QE (the newly-injected cash will stay parked in reserve accounts) and the sole remaining effect, as pointed out by Brad DeLong, is through a “correction” for any premiums demanded for duration risk.
    end quote

    Exactly – they are sterilizing their own policy – working hard to make it fail.

    As Bernanke knows. He says so in the WaPo this morning:

    http://www.washingtonpost.com/wp-dyn/content/article/2010/11/03/AR2010110307372.html?hpid=topnews

    begin quote
    Although asset purchases are relatively unfamiliar as a tool of monetary policy, some concerns about this approach are overstated. Critics have, for example, worried that it will lead to excessive increases in the money supply and ultimately to significant increases in inflation.

    Our earlier use of this policy approach had little effect on the amount of currency in circulation or on other broad measures of the money supply, such as bank deposits. Nor did it result in higher inflation. We have made all necessary preparations, and we are confident that we have the tools to unwind these policies at the appropriate time. The Fed is committed to both parts of its dual mandate and will take all measures necessary to keep inflation low and stable.
    end quote

    The inflation hawks have him so scared that he is proud of thew fact that previous asset purchases had little effect on the money supply – proud of it. He is aiming to fail – charming.

    But still – it is in fact working. And if Ben really will just keep on doing this until it works, then it will work – even if he expects it to fail.

  33. Gravatar of scott sumner scott sumner
    4. November 2010 at 06:07

    David Pearson, The Fed looks at both forward and backward looking data. I think they should focus exclusively on forward-looking data.

    Regarding the bond yields, note that even 7 and 10 year yields rose. Also note that TIPS spreads rose along with real rates. So part of the rise related to inflation expectations. Indeed inflation expectations crept still higher this morning, along with higher stock prices. I do think the rates are reacting partly to economic fundamentals, as we often see stronger growth depress bond prices even on days when the Fed does nothing. But I don’t doubt that your explanation is part of the story.

    Richard, Good points, but in general the immediate reaction is best from a “ceteris paribus” perspective. If you wait a few days then other market influences come into play. But I agree that the changes were so modest this time that it’s hard to draw strong conclusions.

    Marcus, I agree with you a a broad overall sense. I was just trying to dissect the response to show how monetary policy can affect different maturities in different ways. It was a sort of “teaching moment.” I may do more on this today.

    Shane, There will generally be enough T-bonds for the needs of the central bank, but if not, the fiscal authorities face the same problem, with or without the Fed. If the government runs surpluses, and pays off the national debt, where do they put the surpluses? You are a back deciding whether the government should buy stocks, put it in banks, etc. That politicizes the economy. So yes, from a libertarian perspective there is an argument for a modest national debt.

    Marcus#2, It’s hard to tell what will happen, because if the economy does recover (which is possible) the current zero target rate will gradually become more expansionary. The recovery could build up steam. All I meant by the opening is that I am not a prophet. I can say money is now too tight relative to market expectations, but expectations aren’t always 100% right.

    Randall, Base money stays in the US, especially excess reserves. Credit may go overseas–that’s a different issue. Right now we borrow much more from the rest of the world than we lend. If we start lending more than we borrow, our trade deficit will become a surplus.

    Matpw, He is wrong about Japan, the problem there is a tight monetary policy, as the BOJ is opposed to any inflation. They succeeded in getting what they wanted.

    More to come . . .

  34. Gravatar of Kent Willard Kent Willard
    4. November 2010 at 07:21

    I don’t get it. The Fed creates more money and buys more assets. Asset prices increase, but not income. Bank cash increases, but not bank lending. What is the point?

    http://www.kentwillard.com/5-ducats/2010/11/how-is-quantitative-easing-stimulative.html

  35. Gravatar of W. Peden W. Peden
    4. November 2010 at 08:33

    It doesn’t necessarily mean anything in the long run, but I notice that the FTSE got very excited by QE2-

    http://www.bbc.co.uk/news/business-11691638

    From an international perspective, this has been a bit like betting money on a horse, and then the jocket doesn’t hit the horse’s backside for ages because he’s afraid to lose credibility with the horse if it doesn’t get moving. Finally, the Fed has warmed (a LITTLE) to the idea that it’s better to try to win rather than be sure to lose.

  36. Gravatar of James in London James in London
    4. November 2010 at 09:20

    “Base money stays in the US, especially excess reserves. Credit may go overseas–that’s a different issue.”
    If American corporates invest their cash hoards overseas is that credit going overseas? If American households buy foreign bonds and equities via funds is that credit going overseas? Doesn’t base money stays in the US by definition, as you only count what stays in the US as base money. Doesn’t base money that has left,ceases to become base money?

  37. Gravatar of Simon K Simon K
    4. November 2010 at 10:56

    James – Money can’t leave the US dollar economy. Once its created it can only be destroyed by the bank that created it, in this case the Fed. It can be used to buy foreign currency and that foreign currency can be used to buy foreign assets, but the dollars remain dollars and continue to circulate in the US economy. The fact they go via the accounts of some ForEx dealer doesn’t make any difference.

  38. Gravatar of mlb mlb
    4. November 2010 at 12:44

    Market down over 1% today priced in gold. I’d say that is a vote of no confidence.

  39. Gravatar of Simon K Simon K
    4. November 2010 at 12:48

    mlb – The intent is to create inflation. So, uh, no.

  40. Gravatar of mlb mlb
    4. November 2010 at 12:55

    I would argue the intent is to create the type of inflation that stimulates overall wealth creation. When equities go down in terms of gold it tells me that wealth will not keep pace with inflation – i.e., the country is getting poorer.

    Scott, since you are a big fan of EMH how do you explain the fact that inflation expectations havent budged in the last month despite large moves in commodities, gold, USD, equities, etc.? Is it possible that any increase in commodity-driven inflation has an equal and offsetting decrease in other components of inflation? As a simple example, as oil goes up people have less disposable income and can buyer fewer goods. This market action is very hard to explain otherwise. The bond market is saying the Fed is helpless to raise CPI.

  41. Gravatar of Simon K Simon K
    4. November 2010 at 13:40

    mlb – The TIPS spread widened both at last week’s auction in advance of the announcement yesterday, and further at today’s auction. 10 and 30 yr yields widened further today. On what basis are you saying inflation expectations haven’t budged?

    I don’t see the gold price as a reliable indicator of anything except what people who like to own gold are doing.

  42. Gravatar of Richard W Richard W
    4. November 2010 at 14:37

    mlb
    4. November 2010 at 12:55

    ;’ Is it possible that any increase in commodity-driven inflation has an equal and offsetting decrease in other components of inflation? As a simple example, as oil goes up people have less disposable income and can buyer fewer goods. This market action is very hard to explain otherwise. The bond market is saying the Fed is helpless to raise CPI. ‘

    Cost shocks such as increases in the price of oil tend to have different effects compared to the 1970s. If inflation expectations are well-anchored the increases tend not to generate the same second-round effects. For a given level of total nominal demand, an increase in the price of some goods will reduce the income left to spend on other goods, so putting downward pressure on those prices. Firms respond to higher input costs by seeking ways to reduce other costs. The energy shocks in the 1970s were quite different and generated positive second-round effects on wages and the prices of other goods and services. With the main central banks moving to maintaining overall price stability, there is often an inverse relationship between domestic non-energy inflation and energy and import inflation. So cost shocks do not generate second-round effects in the way that they did in the past.

  43. Gravatar of scott sumner scott sumner
    4. November 2010 at 16:29

    JTapp, No, I think you’d compare the 25 basis points on reserves to their other possible assets. Deposits are a liability. T-bills yield less than 25 basis points.

    MBP, Maybe, but also check out my new post.

    Christopher, I think it is a please try mandate.

    Benjamin, You and Krugman. But I don’t think we need close to 5% inflation. We had less than 5% in the Volcker recovery, when RGDP grew 7.7%.

    Jeff, Yes, that’s a good example. The whole labor market question is still poorly understood. It’s probably explained by many different economic models, all mixed together.

    Manny C, Thanks for that link, I hope GS is right about more QE in 2011 and 2012.

    Kramer, Yes, I hope this brings higher rates.

    Doc Merlin, Yes, asset prices move before the CPI.

    Morgan, Thanks for that Bernanke quotation–it’s worth a post.

    123, Maybe, but my new post suggests it’s more than just the bond purchase effect.

    Marcus, Yes, the Bernanke article JimP and Morgan linked to suggests that QE will be the new ffr, until the ffr rises above zero.

    James, Actually, I share Friedman’s skepticism about government. I want a small government, and I want the market, not the Fed, to run monetary policy.

    JTapp, The solution for emerging markets is very simple–revalue as needed to keep NGDP growth on target.

    JimP, Yes, I think you correctly interpreted the WaPo article. I need a post on that.

    Kent, Asset prices increase immediately–income takes time.

    W.Peden, I think today’s reaction in the markets may partly reflect the Bernanke article.

    James, You are getting confused by terms. Corporations don’t literally have “cash” hoards, they have financial assets. Base money counts whether in or out of the US. Indeed the Fed doesn’t even know where it is.

    mlb, The point is to raise asset values relative to wages, not relative to gold. 5 year TIPS spreads have risen from about 1.2% to 1.6% since QE2 talk started. That’s significant, although more is needed.

  44. Gravatar of JTapp JTapp
    4. November 2010 at 17:30

    @ssumner If the Fed buys a $1,000 bond from me and credits my bank’s reserve account with the Fed, my bank’s assets and liabilities initially increase by $1,000. If the FDIC charges 30 basis points on the deposits while the Fed pays 25 basis points on the reserves doesn’t the bank earn less on those reserves than what they pay?

  45. Gravatar of tingsing tingsing
    4. November 2010 at 18:05

    @
    [Simon K
    4. November 2010 at 10:56
    James – Money can’t leave the US dollar economy. Once its created it can only be destroyed by the bank that created it, in this case the Fed. It can be used to buy foreign currency and that foreign currency can be used to buy foreign assets, but the dollars remain dollars and continue to circulate in the US economy. The fact they go via the accounts of some ForEx dealer doesn’t make any difference.]

    If the above were true it would mean that the dollar notes I
    have stashed away in my Swiss Bank deposit box in Zurich are fake??

  46. Gravatar of james in london james in london
    4. November 2010 at 23:56

    Simon K (and tingsing)
    The US dollar economy isn’t only in the US. The world outside the US is heavily US$ dollarised and has much less problematic fiscal deficits (even surpluses) than the US. It is a more attractive place to invest those US$. Scott and his friends should stop being such “little Americans”. Those newly printed US$ can and will end up outside the US, in real economies. However, they will inflate those economies, too, when they already have plenty of growth and inflation.

  47. Gravatar of Doc Merlin Doc Merlin
    5. November 2010 at 01:47

    @james in london

    Yes, this will likely increase price inflation in the far east and cause price deflation in the eurozone. (at least initially.)

  48. Gravatar of Doc Merlin Doc Merlin
    5. November 2010 at 01:53

    @Scott:
    ‘Doc Merlin, Yes, asset prices move before the CPI.’

    But its worse than just that, they don’t move uniformly, so people move their savings into assets that are increasing in relative price faster, trying to protect their savings, and you get asset bubbles. QE is a bad, bad idea.

  49. Gravatar of Simon K Simon K
    5. November 2010 at 10:20

    James – You’re still conflating money and credit. It isn’t possible to invest money – you use money to buy debt (or equity), and that process is investment. The only thing you can do with money is spend it, and you can only spend it on things that are priced in that currency (dollars). Once you spend it, the money goes elsewhere. To invest in non-dollar-denominated assets you have to use dollars to buy some other currency and then use that to buy debt. An increase in the supply of dollars can only inflate the prices of assets priced in dollars. If people do indeed use their dollars to buy foreign debt, it will lower the dollar-to-whatever exchange rates. The only way it can have an role in inflation of non-dollar prices is if other central banks try to preserve their dollar exchange rates in the face of capital outflows from the US. Personally I find it hard to say “capital outflows from the US” without laughing. Yes, some high business and finance transactions and several basketcase economies are dollarised, but compared with the supply of US dollars, the currency needs of these transactions are miniscule.

    tingsing – Have you tried buying anything with them in Switzerland, other than swiss francs or Euros? They’re dollars. You can only use them to buy things prices in dollars.

    Doc – Doesn’t the criticism apply to any variation in the money supply at all?

  50. Gravatar of JTapp JTapp
    5. November 2010 at 13:09

    James in London,
    As Scott said elsewhere in a response to me: Those countries’ central banks should stop worrying about defending their pegs and start targeting NGDP.

  51. Gravatar of james in london james in london
    6. November 2010 at 08:26

    Simon K
    Surely you must know that the world’s commodities are mostly priced in US$. Many corporates and banks have two balance sheets, a local one and a US$ one, even if they report in local non-US$ currency. Many can easily operate in any major currency. Forex swaps also make it easy to operate more or less anywhere in any currency. US$ money flows cannot be imprisoned only in the territory of the US. Globalisation has made the world much more US$-dollarised than you think.

    JTapp
    It’s just so arrogant to think that the US can act alone. The world’s not like that anymore. There is no magic wand solution to the problems of the US, fiscal discipline is what is needed. The fact that the US mortgage market is now more or less owned (nationalised) by the US government is so indisciplined and socialistic that there can only be a long and painful readjustment, short of strong asset price inflation – and the concomitant tax on the savers.

  52. Gravatar of james in london james in london
    6. November 2010 at 08:53

    Scott
    What doest Google have if not a $50bn cash hoard. Of course it is invested in very low yielding bank accounts and government secturities. It’s not under the bed for sure, but then you probably wouldn’t call it cash ,then, but “under-the-bed” financial assets. Why are they,and other corporates and individuals and funds, hoarding it is the question. The answer is lack of confidence in the US economy. Principally due to the bills come home after years of a sort of public/private “socialism” via direct and implicit state guaranteed credit creation caused the housing bubble.

  53. Gravatar of scott sumner scott sumner
    6. November 2010 at 11:14

    JTapp, I can’t answer that, perhaps;

    1. The 30 basis points only applies to some types of deposits.
    2. They earn it back in fees.

    I honestly don’t know, but assume banks aren’t fools.

    Oh wait . . .

    tingsing, That’s right. But it’s still in the dollar economy, it doesn’t affect Swiss prices.

    James, The dollar is not a medium of account in other countries, so it doesn’t inflate their economies (unless they peg–which is their choice). Foreign central banks determine their inflation rates. Believe me, I understand the issue you are raising, but you are wrong.

    Doc Merlin, You can’t “move money” into the gold market, there’s no place to put it.

    James, I doubt there was much confidence in the Zimbabwe economy a few years back, but they somehow increased their NGDP pretty fast. Believe me, confidence is not the problem. If there is any lack of confidence, it is because the Fed is too contractionary.

  54. Gravatar of james in london james in london
    6. November 2010 at 12:48

    JP Morgan employees in London (I am not one, btw) get paid in US$. They run their business in US$. Same for other IBs. Same goes for lots of other US and international companies. You are too narrow in thinking countries as discrete entities, you are too wrapped up in macroeconomics where you need discrete countries with their currencies and only modest, insignificant leakages. But the world isn’t a macroeconomics lab. That’s why lots of people think you and Bernanke are crazy professors!

  55. Gravatar of Randall Randall
    7. November 2010 at 08:17

    Scott, Help me understand. The Fed purchases securities from a bank, such as BOA. The bank(BOA) now has more cash on hand, they can lend this money or move it to the other side of the balance sheet and make investments in securities? Am I understanding this correctly?

  56. Gravatar of ssumner ssumner
    7. November 2010 at 12:30

    James, Haven’t you noticed by now that I am not a monetarist, that I don’t care what the money supply is. None of the arguments you raise have any bearing on my policy propsals. Lets say 50% of dollars are overseas–how would that change any of my policy proposals? Does it mean IOR has no effect on money demand? Does it mean QE has zero effect on the US held monetary base? If not, precisely what is your point.

    Since I don’t agree with Bernanke on monetary policy (have you noticed he doesn’t favor targeting the forecast?) I can’t imagine why you are lumping him in with me.

    The people that have their heads in the sand, that pay no attention to the real world, are those who deny the obvious fact that chatter about QE raised the price of stocks and foreign during September and October. They have no explanation for that fact.

    Randall, I think you mean the same side of the balance sheet. Both cash (i.e bank reserves) and other investments like bonds and loans are considered bank assets.

  57. Gravatar of James in London James in London
    8. November 2010 at 04:10

    “I want the market not the Fed to run monetary policy”
    If the market doesn’t want US$, why produce more?

  58. Gravatar of Doc Merlin Doc Merlin
    8. November 2010 at 13:15

    ‘Doc Merlin, You can’t “move money” into the gold market, there’s no place to put it.’

    While this is true, its meaningless. I didn’t say moving money into the gold market, I said moving your savings to gold. That just means buying gold or gold backed assets (ETF etc.) with your dollar denominated savings.

  59. Gravatar of Randall Randall
    8. November 2010 at 15:02

    Scott, Help me understand. The Fed purchases securities from a bank, such as BOA. The bank(BOA) now has more cash on hand, they can lend this money or make investments in securities? Am I understanding this correctly?

  60. Gravatar of ssumner ssumner
    8. November 2010 at 18:20

    James, You said:

    “If the market doesn’t want US$, why produce more?’

    In monetary economics that’s a nonsensical statement. Do you think Bernanke puts a gun to people’s heads in the bond market? Whether people “want” money in the abstract is beside the point, you produce as much as people want when the economy is at the nominal target.

    Doc, for everyone who buys gold someone else sells gold. Sure you can encourage new production, but that’s not a big issue.

    Randall, Yes.

  61. Gravatar of Richard W Richard W
    8. November 2010 at 21:19

    Randall
    8. November 2010 at 15:02

    ‘ Scott, Help me understand. The Fed purchases securities from a bank, such as BOA. The bank(BOA) now has more cash on hand, they can lend this money or make investments in securities? Am I understanding this correctly?

    ssumner
    8. November 2010 at 18:20

    Randall, Yes. ‘

    They would get much better traction if the QE was biased towards buying assets from non-banks. The broad money transmission mechanism is a much more powerful QE than the quasi-credit easing of buying assets from the banking sector.

  62. Gravatar of Not Bad, But Where Is the Explicit Nominal Target? : Invest My Money Not Bad, But Where Is the Explicit Nominal Target? : Invest My Money
    9. November 2010 at 00:02

    [...] are some of the discussions on the FOMC’s decision: Scott Sumner, Ryan Avent, Mark Thoma, Brad DeLong, James Hamilton, Paul Krugman, Gavyn Davies, and Bill [...]

  63. Gravatar of ssumner ssumner
    9. November 2010 at 08:06

    Richard, You may be right. there are many issues that come into play here:

    1. The direct effect on asset prices of asset purchases.
    2. The issue of interest on bank reserves.
    3. The way different types of asset purchases might send different signals about the Fed’s long run inflation intentions.

    In theory, it should matter all that much what they buy (in normal times), but because of the factors I cited above, I’m not willing to disagree with your assertion that other actions might have a bigger effect.

  64. Gravatar of QE II « Kantoos Economics QE II « Kantoos Economics
    10. November 2010 at 02:13

    [...] zweites Programm zur quantitativen Lockerung (quantitative easing, QE) präsentiert. Die Reaktion der Märkte fiel bescheiden aus, allerdings war das Paket angekündigt, von daher hatte der Markt den Großteil [...]

  65. Gravatar of TVHE » Good points on QEII TVHE » Good points on QEII
    10. November 2010 at 15:38

    [...] would still agree overall with Scott Sumner’s point that we should judge the policy based on where market expectations for future inflation move [...]

Leave a Reply