Do the QE opponents have ANY good arguments?

I hope this is my last attack on conservative opposition to QE2, as I am getting sick of the topic.  I’ll try to summarize all their arguments here, to see if any are even slightly defensible:

1.  Inflation only seems low because the Fed ignores food and energy.

The core rate is only 0.6%, but even the overall CPI is only running 1.2%.  So that argument is flat out wrong.  Yet it doesn’t stop some people from making it.

2.  History shows that when central banks print lots of money, high inflation results.

Actually no.  History shows that when central banks print lots of money at the zero rate bound, one generally doesn’t get much inflation.  Japan has been printing lots of money for years, and has also run big budget deficits—thus they’ve been monetizing the debt.  And their price level is lower than in 1994. 

3.  Japan is different.  When the Fed has printed lots of money we’ve had high inflation.

Actually no.  Again, when at the zero rate bound, printing money is not necessarily inflationary.  The Fed printed lots of money in the 1930s, indeed the monetary base nearly tripled.  Yet the price level fell during the 1930s.

4.  The gold market shows that high inflation is just around the corner.

Actually no, for reasons discussed in this earlier post.  Every direct indicator we have of inflation expectations shows very low inflation in the years ahead.  CPI futures markets, 5-year TIPS spreads, the consensus economic forecast, they all point to low inflation. 

5.  OK, in the past printing money didn’t produce high inflation at the zero rate bound, and we don’t have high inflation now, and both forecasters and markets tell us not to expect high inflation in the future.  But I just can’t believe we can print that much money without eventually suffering from high inflation.  Monetarist theory tells us . . .

Monetarist theory has nothing to do with the current policy environment.  Monetarist theory is all about the impact of printing non-interest bearing money–aka “high-powered money.”  The reason it’s called high-powered is because it lacks interest, and thus is a sort of “hot potato,” an asset that everyone tries to get rid of, and the in process drives up prices.  Milton Friedman and Karl Brunner would be rolling over in their graves if they knew people were claiming monetarist theory meant than the issuance of reserves paying interest at rates higher than earned on T-bills was some sort of “high-powered money.”

6.  If the policy does raise NGDP, interest rates will also rise, causing the Fed to suffer capital losses on its large bond portfolio. 

Conservatives presumably believe in efficient markets, and thus the expected loss is approximately zero.  The term structure of interest rates has already priced in the expected increase in rates that will occur as the economy recovers.  Yes, there is some risk, but far less than people think.  The Fed is mostly buying medium terms bonds, for which the price risk is rather low.  And if the recovery is much stronger than expected, the gains to the Treasury would far exceed the losses to the Fed.  This is NOT an argument for leaving millions of workers unemployed.  Especially given that the Fed took far greater risks to save the big banks.

7.  Yes, they are paying interest in reserves, and that prevents inflation right now, but when the economy recovers there will be tremendous pressure on the Fed to avoid raising the interest rate on reserves, and they will spill out into the economy. 

Even distinguished economists such as Becker and Posner are making this argument, but I find it the most perplexing and feeblest argument of all. 

Right now the Fed is under tremendous pressure not to do more monetary stimulus, despite 9.8% unemployment and below target inflation.  There is little pressure on the Fed to do more.  Yet somehow we are to believe that when the economy recovers somewhat and inflation is much higher, and unemployment is lower than today, there will be tremendous pressure on the Fed to not raise rates?  And all this despite the fact that the Fed is almost universally blamed for holding rates too low for too long, and inflating the housing bubble?  That makes no sense.

Even worse, we need easier money to reduce that part of unemployment that is not structural; almost certainly a substantial share of the 8 million jobs lost in the recent recession was cyclical.  NGDP is not now growing fast enough to rapidly reduce unemployment.  I don’t expect the 11% NGDP growth we saw in the first 6 quarters of the (low inflation) Volcker recovery of 1983-84, but surely we can at least raise NGDP growth a bit higher than the current path?  How can we in good conscience tell the Fed not to do the right thing, and ease the enormous suffering caused by unemployment, solely because we fear they might do the wrong thing in the future?  Especially given that there is little political pressure on them to inflate now, when you’d think the political benefit of easy money would be greatest?  Obama didn’t even nominate three people for empty Fed seats for 15 months, which shows how little the liberal establishment cares about monetary policy.  And we are to believe that in the near future when the need for monetary stimulus is far less, Obama will suddenly morph into a latter day William Jennings Bryan and start pressuring the Fed?

So there you are.  The conservatives do not have a single good argument against QE2.  Every argument is based on bad logic, bad economics, a lack of understanding of history, or a lack of understanding of our political system.   There must be some reason why the conservative establishment hardly raised a peep when the Fed would cut rates when inflation was running 3% or 4% when Reagan was president, or when Bush was president, and yet are now up in arms over monetary stimulus when we have 1% inflation and 17 million people out of work.  There must be some reason.  But for the life of me, I can’t figure out what it is.

OK, I’ll get off this topic, and wait for conservatives to explain to me what’s going on.

And when we figure that out, then we can work on the even more bizarre opposition from certain voices on the left.  But perhaps I should leave it to Krugman to figure out what’s going on in the mind of that other outspoken, prickly, left-wing pundit and Nobel laureate.  Joe Stiglitz.


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50 Responses to “Do the QE opponents have ANY good arguments?”

  1. Gravatar of JimP JimP
    6. December 2010 at 06:49

    Canada and price level targets:

    http://www.bloomberg.com/news/2010-12-06/fed-avoiding-deflation-may-depend-on-canadian-experiments-in-cpi-targeting.html

    And an interesting quote from the article:

    Begin quote
    The experiments will help Canada decide if it should switch from inflation targeting to price-level targeting in 2012 and may help the bank better communicate its policies to the public, Boivin said. The test results also might benefit Fed policy makers, who discussed price-level targets on Oct. 15 and voted Nov. 3 to inject another $600 billion of reserves into the banking system to avoid deflation — a widespread drop in prices that has plagued Japan for more than a decade.
    End quote

    So the Fed hass discussed price level targeting. That is clearly a step foward.

  2. Gravatar of David Pearson David Pearson
    6. December 2010 at 07:37

    “Yet somehow we are to believe that when the economy recovers somewhat and inflation is much higher, and unemployment is lower than today, there will be tremendous pressure on the Fed to not raise rates? ”

    An economy that “recovers somewhat” grows around 2.5% p.a. At this rate the unemployment rate would not be “lower than today”. If there is “much higher” inflation with that unemployment rate, of course the Fed will not tighten. In fact, at the time, it is likely that monetary stimulus proponents would argue, “we want temporarily high inflation; as the SRAS curve is positively sloped, real growth will eventually move higher.”

    The question for stimulus proponents is this: at what combination of slow real growth and high inflation, for what time persistence, would you argue that the Fed needs to tighten? For instance, a 5yr TIPS inflation spread of 3.5% and expected growth of 2.5% would imply an overshoot for 5yrs of a 5% nominal target. Is 5yrs okay? What about a 3.5% 10yr TIPS spread? Should the Fed tighten then?

    The problem is that 2.5% real growth is highly insufficient. We need the economy to grow by more than 3.5%+ to bring UE to a level where the Fed could actually tighten. Anything less, and its hands will be very much manacled by the reality that tightening with high unemployment could cause deflation. You know this, which is why you are calling for “temporarily high” inflation. Conservatives worry that the distinction between “temporary” and “permanent” rests on the Fed’s success in reducing unemployment, a success which is very much in doubt.

  3. Gravatar of james in london james in london
    6. December 2010 at 07:45

    Is it conservative to say QE2 is wrong because of the moral hazard it will create in bailing out the banksters? Or is that a liberal argument against QE2? Or is it an Austrian argument against QE2? Anyway, it is the argument I am waiting for you to address.

  4. Gravatar of Dustin Dustin
    6. December 2010 at 08:30

    “There must be some reason why the conservative establishment hardly raised a peep when the Fed would cut rates when inflation was running 3% or 4% when Reagan was president, or when Bush was president, and yet are now up in arms over monetary stimulus when we have 1% inflation and 17 million people out of work. There must be some reason. But for the life of me, I can’t figure out what it is.”

    ———————————————————————

    You really don’t know, or you’re just kidding around?

    It’s all very simple, of course. The number one goal is to see Obama defeated in 2012. It’s imperative. A dismal economy helps accomplish that (big time!).

    Monetary stimulus might work. So, because it might work, it must be stopped. Any possible downside, or any argument against it (whether right or wrong), must be magnified and stressed.

    Beck already has his (large) audience extremely sensitized to coming inflation. At the first sign of inflation, he will pounce, and send forth his hordes. He, along with Palin, Rush, Hannity, etc., are today’s conservative drivers. Conservative economists just get snowballed down the hill.

    Any principled conservative who says we should do the right thing now, and let the political chips fall where they may, will be brushed aside. It’s imperative that the Atheist/Marxist/Kenyan/Muslim/Socialist in the White House be defeated in 2012, at any cost.

  5. Gravatar of Benjamin Cole Benjamin Cole
    6. December 2010 at 09:28

    James Suroweicki, the very good New Yorker columnist, flat out says Republicans are against QE2 as they hate Obama.

    This is yet another terrific blog by Scott Sumner, currently the nation’s most valuable economic commentator.

  6. Gravatar of Cameron Cameron
    6. December 2010 at 09:59

    I think it’s simple : Both conservatives and liberals think the fed funds rate + the size of quantitative easing is a good indicator of policy and see the interest rate mechanism as the only effect of monetary policy.

    As a result both seem to think it won’t help the economy (interest rates are already really low!). But while conservatives are worried about inflation (because in their minds, policy is already so easy and interest rates can’t go lower), liberals believe we are in a liquidity trap and basically don’t care about the Fed.

    Obviously most of us here probably reject associating low rates with easy money, and reject the interest rate mechanism as being the only effect monetary policy has… but if you believe those things what both sides are saying makes sense.

  7. Gravatar of Anton Tonev Anton Tonev
    6. December 2010 at 14:44

    I agree with all the above arguments as reasons not to oppose QE – most of them focus on the effect of QE on inflation anyway and, if by some miracle, inflation were to occur, I think you ought to put that as positive given the current debt problem we have! But if QE is sterilized as it is in this case, can you please tell me how it is actually going to work apart from the wealth effect (there is no argument here as asset prices have gone up since the August announcement)? I am assuming money multiplier of close to zero unless you can explain to me under what circumstances it will rise from its current level (of close to zero).

  8. Gravatar of TravisA TravisA
    6. December 2010 at 14:57

    Scott, theoretically what should happen to NGDP and inflation if the Fed buys medium term notes and almost all of the money goes into excess reserves?

    Did you see this article about Bernanke? Here’s the money quote:

    “The amount of currency in circulation is not changing,” he said. “The money supply is not changing in any significant way. What we’re doing is lowering interest rates by buying Treasury securities.”

    It seems that the Bernanke doesn’t want to increase the monetary base. He wants to instead lower long term rates. Can that policy by itself increase NGDP and inflation?

    When I read Krugman and Delong talking about how QE2 wouldn’t have much impact because QE2 would only change the term structure, I thought they were crazy. But it seems that is what Bernanke wants too! Unbelievable.

  9. Gravatar of TravisA TravisA
    6. December 2010 at 14:58

    Whoops. Here’s the link:

    http://www.bloomberg.com/news/2010-12-06/bernanke-says-more-fed-easing-possible-with-jobless-rate-high.html

  10. Gravatar of Morgan Warstler Morgan Warstler
    6. December 2010 at 15:04

    “Inflation only seems low because the Fed ignores food and energy.”

    I don’t say that, I say it shouldn’t count rents – you never respond.

    If we toss the Mortgage Deduction, you will be arguing for QE as home prices fall.

    “And if the recovery is much stronger than expected, the gains to the Treasury would far exceed the losses to the Fed. This is NOT an argument for leaving millions of workers unemployed. Especially given that the Fed took far greater risks to save the big banks.”

    I’m going to answer this along with the BIGGER POINT, which you refuse to respond to…

    MACRO IS POLITICAL. So if you want some QE3, you are going to have to get out there an become the poster boy for cutting Public Employee Compensation.

    It is one thing to say “Sticky Wages!” like it is a fact

    And quite another to not actively argue for unsticking wages WHERE WE CAN.

    It seems to me if you have a GUARANTEE from Benji for 2% CPI, than you should be going balls to the wall on promoting deflationary fiscal policies.

  11. Gravatar of W. Peden W. Peden
    6. December 2010 at 15:13

    James in London,

    It’s an argument that can be made by anyone who commits the fallacy of division: something that may be desirable overall may not be desirable in every detail. Any tax regime will have some contemptible cases, but some tax regimes are better overall than others.

  12. Gravatar of colintj colintj
    6. December 2010 at 15:42

    Here’s an argument I’ve been seeing, which in Felix Salmon’s terminology boils down to “but what about fat tails?”

    http://ultimibarbarorum.com/2010/11/16/quantitative-queasing/

    The post author calls QE “Pet Semetary Economics”. Which sounds cool at least. And I don’t think it fits into any of the ones you mention here, but perhaps it was addressed in a different post. I thought it was interesting, but I’m no subject matter expert.

  13. Gravatar of Mark A. Sadowski Mark A. Sadowski
    6. December 2010 at 17:48

    Scott wrote:
    “1. Inflation only seems low because the Fed ignores food and energy.”

    Back when headline PCE fell 2.1% between July and December 2008 (5.1% at an annual rate) the “inflationistas” (at least the ones that don’t think the inflation indicies are a government conspiracy) were screaming “forget headline inflation, it’s core inflation that really matters”. My what a difference two years makes!

    All that deflation is now conveniently down the memory hole. It took until December 2009 before headline PCE exceeded July 2008 (17 months). As of October it was 1.0% higher for an annual rate of (gasp!) 0.4%. Over the same period core PCE is up 1.2% at an annual rate.

    That’s the whole reason we look at core inflation. It’s less volatile.

    But I’m not concerned about the missguided ravings of a bunch of hyperinflation fearing knuckleheads. I’m much more concerned about the poor prediction record of the major modelers. The Survey of Professional Forecasters (which includes such extremist organizations a Moody’s economy.com, Macroeconomic Advisers, IHS/Global Insight, Goldman Sachs etc.) has consistently overforecasted core PCE one year out since the recession began. In 2009Q1, 2009Q2 and 2009Q3 they forecasted core PCE would rise 1.4%, 1.4% and 1.3% respectively in 2010Q1, 2010Q2, 2010Q3. The actual record was 1.2%, 1.0% and 0.8% respectively.

    Now, presumably the major modelers take into account facts such as unit labor costs plunged 4.6% between 2008Q4 and 2010Q1 and have been essentially flat since. But yet they have been consistently overestimating core inflation. And when such mainstream sources are consistently overestimating future inflation what does that tell you about the predictions of the inflationistas (and their beliefs concerning the ratex Phillips Curve)?

    P.S. The SPF is currently forecasting that core PCE will rise at an annual rate of 1.3% in 2011Q4 (despite the fact they also are forecasting unemployment will be 9.0%). Don’t you believe it!

    P.P.S.The food component of the PCE peaked in November 2008 and fell a total of 2.0% by September of 2009. Then it rose modestly through April of 2010 (at about a 1.9% annual rate) but since April it has only risen at an annual rate of only 0.5%. The index is still 0.5% below the previous peak nearly 2 years ago. I perceive the modest rise it experienced late last year through early this year as a “dead cat bounce” after nearly a year of deflation.

    Similarly the energy component of the PCE peaked in July 2008. It plunged 36.2% by December 2008. Then it bounced back up 23.9% through January 2010. Since January it has risen at an annual rate of only 0.2%. It’s still off 20.5% from its previous peak over two years ago. Last year’s increase was another dead cat bounce.

    So both food and energy have plateaued this year after partially recovering from a drop.

    In short both food and energy (but especially energy) are volatile. They are dropped from core inflation precisely because they have a tendency to gyrate, often dramatically. So the real story about food and energy prices over the last three years is no story.

    P.P.P.S. According to the Energy Information Administration gasoline is the same price at the pump it was in October 2007, over three years ago.

  14. Gravatar of Morgan Warstler Morgan Warstler
    6. December 2010 at 18:33

    http://finance.yahoo.com/news/Retail-pump-prices-hit-apf-2977939409.html?x=0&.v=2

    Mark, it gives me personal joy to watch the world you wish for and contort facts to achieve be torn from your grasp.

    Warm smiles. And a loving confidence in the real folks that make things happen.

    When you can learn to cheer falling home prices and hate increasing energy and food prices – you will be a far better economist with a much better chance of doing something meaningful for your side.

  15. Gravatar of Mark A. Sadowski Mark A. Sadowski
    6. December 2010 at 18:51

    No need to contort facts Morgan. If anything I understated my case. Weekly U.S. reformulated retail gasoline prices (dollars per gallon) averaged $3.101 the week of December 6th 2010. They averaged $3.121 the week of April 30th 2007:

    http://www.eia.doe.gov/oog/info/gdu/gasdiesel.asp?featureclicked=1&#

    Just click on history and choose “more retail gasoline prices”.

    Less hype, more facts please.

  16. Gravatar of scott sumner scott sumner
    6. December 2010 at 18:56

    JimP, Thanks, I did a post.

    David Pearson. Conservatives need to stop worrying so much about inflation and focus on the real problem, which is inadequate AD. I don’t agree that 2.5% growth is partial recovery, it’s not any kind of recovery.

    And I fail to see how there will suddenly be massive pressure on the Fed to ease when we have recovered somewhat, given that most of the pressure now is on them to tighten, and we actually do need to ease.

    James, You asked:

    “Is it conservative to say QE2 is wrong because of the moral hazard it will create in bailing out the banksters?”

    I don’t know if it is conservative, but it is certainly silly.

    Dustin, I think there are some that feel that way, but it doesn’t explain all the opposition. There are very idealistic people who also oppose QE2.

    Thanks Benjamin.

    Cameron, Then conservatives should stop saying they believe in markets, and come out for central planning, as they seem to know better than the TIPS markets what sort of inflation we will get.

    Anton, It probably works through creating expectations of higher future inflation–eventually rates won’t be stuck at zero, and it will work. The current market response is in anticipation of it working in the future. That makes it boost AD right now.

    Travis, See my answer to Anton. Regarding currency, yes most of the new base goes into excess reserves, not currency.

    Morgan, I didn’t say you said it, I linked to someone else.

    colintj, Sorry, I can’t follow that argument at all.

    Mark, All good points. You said;

    “Macroeconomic Advisers, IHS/Global Insight, Goldman Sachs etc.) has consistently overforecasted core PCE one year out since the recession began. In 2009Q1, 2009Q2 and 2009Q3 they forecasted core PCE would rise 1.4%, 1.4% and 1.3% respectively in 2010Q1, 2010Q2, 2010Q3. The actual record was 1.2%, 1.0% and 0.8% respectively.”

    That’s why I prefer the TIPS spreads. They were around 1% over one and two years, as I recall.

  17. Gravatar of MikeDC MikeDC
    6. December 2010 at 19:46

    Am I really dense (very possible) or is Argument #7 mangled?

    Becker’s argument, at least, is not based on IOR, but seems to be based on regulatory uncertainty. Unfortunately, I think Becker is mangling his point as well. He says:

    This is partly due to government policies, like the health care and the financial reform bills, and proposals to raise taxes on higher incomes and on capital gains that will raise costs of doing business, and lower after-tax incomes of investors. Perhaps that perception will change due to the recent election of many Congressmen who say they want to lower taxes and reduce the size of government, but this perception of a risky investment environment will not change because the Fed creates large quantities of additional reserves.

    To me, this sounds much more like Knightian uncertainty than risk. Risk has a price, and the right combination of IOR and additional money should clear any market. Not so if you’ve got incalculable uncertainty.

    So the argument to respond to would be that Knightian uncertainty will prevent QE from having much effect now, but, when resolved, will make those excess reserves an inflation bomb.

    Alternatively, even if we’re talking about calculable risks, isn’t it a justified believe that the market isn’t clearing because:
    1. Regulatory, business and tax risks to potential borrowers are high enough that they will borrow at only a very low price (the rates they would get).
    2. Prices (the Rates banks get by lending) that would be attractive to borrowers are lower than the prices banks get by simply accruing interest on their reserves.
    3. Hence, QE is simply pouring more product into a market that’s not clearing.
    4. And if the market becomes responsive again (which could happen quickly and unexpectedly), the massive “inventory” of dollars sitting there becomes destabilizing.

    Simply put, the market needs to be fixed before we can expect it to work, and QE puts the cart before the horse. I don’t know if that’s right, but it seems a fairer reading of what Becker is getting at. And Becker ain’t no dummy.

    That being said, another thing I found interesting was his assumption that the legal distinction between excess and required reserves was all that meaningful.

    He writes:

    Yet the Fed’s creation during the past couple of years of well over trillion dollars in additional reserves through open market operations has not induced rapid increases in bank lending. Instead, banks have accumulated huge amounts of excess reserves; that is, reserves above the amount they are required to keep as collateral for their deposit liabilities.

    Isn’t this exceedingly odd, given that we just went through a liquidity crisis in which banks suffered a major drop in the value of their paper assets? I’m not a banker, but wouldn’t the sober thing to do be to establish cash reserves adequate to the circumstances (and these circumstances suggest higher than usual), rather than the bare, legally required minimum?

  18. Gravatar of Mike Sandifer Mike Sandifer
    6. December 2010 at 20:17

    Scott,

    I was wondering if you were going to comment on Stiglitz after watching this today:

    http://www.cnbc.com/id/15840232/?video=1684970043&play=1

    I’m far, far from being an economist, but these ideas on QE strike me as being so bizarre, that I wonder if he has neurological problems, such as perhaps senility. Maybe he’s the liberal answer to Jim Rogers.

  19. Gravatar of Kevin B. O’Reilly Kevin B. O'Reilly
    6. December 2010 at 21:45

    Posner’s not an economist, let alone a “distinguished” one: http://www.answers.com/richard+posner

  20. Gravatar of james in london james in london
    6. December 2010 at 23:36

    W Peden (and Scott)
    At least when you accuse me of the “fallacy of division” you are admitting there is a link between micro and macro. We can then talk about how big it is. I am astounded that Scott tells me off as just being “silly” for confusing micro and macro with with my question: “Whether QE2 encourages banksterdom?”. (Or Morgan’s version: Whether QE2 encourages profligate deficit creation by the US Government and the population that votes for it?”.

    The fact that Scott and other macroeconomists can’t discuss this link between macro and micro undermines his and most other macro. Real people respond to good micro, which renders the notion of macro redundant. Macro that is undertaken for its own ends is usually bad micro and is self-defeating. The “Sumner Put” is one such policy.

    Good micro is a bit like “tough love”, and when people expect macroeconomists to bring in a magic wand solution to micro-misallocations it takes a while for constant failure to sink in and shake the belief in the fairy Fed godmother.

  21. Gravatar of Morgan Warstler Morgan Warstler
    7. December 2010 at 04:03

    Mark, any argument about oil and food that doesn’t say:

    1. we are running out of oil. oil supply drives price of food as well.
    2. easy money drives up commodity prices. 1 cent loss in dollar cause $4 per barrel.

    Is a contorted fact.

    Any argument about CPI, that doesn’t note housing prices are falling and REJOICE in light of horrific pumping caused by both easy money and bad tax policy is contorted. Housing is not an investment, it is a consumable… And we KNOW that rents will continue to fall, because of oversupply caused by easy money, and ending the mortgage tax credit. It is disgusting to use the fixing of tax policy as a justification for printing money.

    I will say it again: When you can start with an uncontorted reality, you will be far closer to achieving something as an economist.

    The world only needs a few DeKrugmans. A little bit of unserious, lack of reality liberals go a long, long way.

    Innovation in the next century is about selling liberals on half a loaf properly earned.

  22. Gravatar of Mark A. Sadowski Mark A. Sadowski
    7. December 2010 at 06:52

    Morgan,
    I prefer PCE to CPI for several reasons. One potential criticism of CPI is that it gives too much weight to housing. But removing the “owner’s equivalent rent” component (consisting of approximately 33% weight in the index) from CPI doesn’t change the disinflation picture much:

    http://economistsview.typepad.com/economistsview/2010/12/frbsf-disinflation-its-not-just-housing.html

    So insisting that the disinflation we’re experiencing is mainly due to declining housing values is itself a distortion of the facts.

  23. Gravatar of Greg Ransom Greg Ransom
    7. December 2010 at 08:05

    Bernanke has sold this on unpersuasive grounds.

    You’ve already explained this.

  24. Gravatar of Rod Everson Rod Everson
    7. December 2010 at 08:46

    Morgan:

    Here’s a graph that clearly supports Mark’s assertion that gas prices, though volatile, have been around these levels for several years.

    http://gasbuddy.com/gb_retail_price_chart.aspx

    Click on the “6 years” link, upper right on the chart. We’ve been at 2.86 several times since 2005. With all due respect, your Yahoo link to a story bemoaning the fact that we’ve never seen $3.00 at Christmas was the misleading one. If that’s true, it’s only because of a sudden dip back below $3.00 right at Christmas in Dec, 2007.

  25. Gravatar of Rod Everson Rod Everson
    7. December 2010 at 09:08

    MikeDC, you wrote: “I’m not a banker, but wouldn’t the sober thing to do be to establish cash reserves adequate to the circumstances (and these circumstances suggest higher than usual), rather than the bare, legally required minimum?

    That might have been the “sober” thing to do in the 1930′s when individuals worried about the financial health of their individual banks, but today the government has essentially backed all deposits so banks have no incentive to carry excess reserves, unless they are either 1) compensated for carrying them or 2) suffer no opportunity cost for carrying them, i.e., at a zero fed funds rate.

    All those reserves will begin to circulate if any of the following happen:

    1. The Fed manages the funds rate to a higher number (my preferred solution.)

    2. The Fed establishes a penalty IOER rate, that is a negative interest rate on excess reserves. To be a penalty at this level, it would have to be a negative rate to be effective.

    But alternative 2 is not going to happen because it would require unwinding QE and QE2 first. The last thing the Fed wants right now is for a trillion dollars of excess reserves to suddenly start circulating. They fully intend that the banks sit on those reserves. QE is about massaging the yield curve, not boosting the money supply.

    QE is also the reason that the Fed’s mandate will soon be restricted to maintaining price stability (however defined) sometime in the future. I just hope that’s done before the whole mess blows up, rather than after.

  26. Gravatar of Rod Everson Rod Everson
    7. December 2010 at 10:33

    TravisA, here’s the rest of the “money quote” you cited:

    “We could raise interest rates in 15 minutes if we have to,” he (Bernanke) said.

    What we’re doing is lowering interest rates by buying Treasury securities.”

    “By lowering interest rates, we hope to stimulate the economy to grow faster,” Bernanke said. “The trick is to find the appropriate moment when to begin to unwind this policy.”

    As I’ve maintained since I started commenting on Scott’s blog a few weeks ago, the Fed could easily raise the fed funds rate any time they want. This is confirmed directly when Bernanke says “we could raise interest rates in 15 minutes if we have to.”

    Unfortunately he also goes on to say that the reason they are lowering rates now is to stimulate the economy. And worse, that it will be a “trick” to know when to unwind the policy.

    Lowering interest rates won’t have nearly the effect that getting excess reserves to start circulating would have. And by the time the Fed finds out just how “tricky” unwinding his current strategy is going to be, he will have lost his mandate to worry about economic activity, and that’s a good thing. We don’t need an unelected government official deciding whether or not the economy needs to be slowed or accelerated. With that power, one can determine the course of future presidential elections.

    It’s time to restrict the Fed’s mandate to one of maintaining stable prices in some form or another and get them out of the business of driving economic growth or, more likely, contraction.

    I explain the reasoning behind my thinking in a monograph that can be found at my now-inactive blog:

    http://ontrackeconomics.blogspot.com/search/label/Priority

    Go to the paragraph “Read the Monograph.”

  27. Gravatar of james in london james in london
    7. December 2010 at 11:44

    Have I missed the demolition of the shadowstats.com by all the inflationists on this blog? Looks plausible to me that the government consistently supresses the inflation rate as so much government spending depends on surpressing the true inflation rate, and so much government tax take depends on having a high inflation rate. Of course, one has to be very careful accusing the government of bias, it’s a very honourable institution after all and completely fair-minded in all it does.
    http://www.shadowstats.com/alternate_data/inflation-charts

  28. Gravatar of MikeDC MikeDC
    7. December 2010 at 12:49

    Rod,
    You write, That might have been the “sober” thing to do in the 1930’s when individuals worried about the financial health of their individual banks, but today the government has essentially backed all deposits so banks have no incentive to carry excess reserves but I’m not sure this is on the mark.

    Where I a banker, I wouldn’t have much confidence that I can continue to call on the government for a bailout whenever the need arises. TARP and the like came at the expense of a big chunk of political capital. I think the politicians of 2011 are more likely to say no, or at least exact a higher price.

  29. Gravatar of Jeff Singer Jeff Singer
    7. December 2010 at 14:18

    Scott,

    Have you responded to all of Taylor’s arguments? Collected in this blog post:

    http://johnbtaylorsblog.blogspot.com/2010/11/qe2-letter.html

  30. Gravatar of Jeff Singer Jeff Singer
    7. December 2010 at 14:26

    Scott,

    Have you responded to Taylor’s arguments:

    http://johnbtaylorsblog.blogspot.com/2010/11/qe2-letter.html

    ?

  31. Gravatar of Rod Everson Rod Everson
    7. December 2010 at 14:57

    MikeDC

    I assume you meant “Were I a banker…”

    I tend to agree with your assessment, but I doubt that the average depositor is evaluating his bank on that basis. I also suspect that the last “higher price” the politicians would consider exacting is the bankrupting of their constituents.

    Of course, over the last few years they’re well on the way to bankrupting the entire country, but that’s another story….

    My point is, excess reserves are not circulating because banks have no incentive to circulate them, and not because they’re holding them to provide more security for their depositors. That was not the case during the 1930′s when bankers felt the need to demonstrate financial soundness on their own accord.

  32. Gravatar of Simon K Simon K
    7. December 2010 at 15:57

    James – Looking over the methodology, it seems like all Shadowstats are doing is adding a fudge factor of 2.9% to the BLS inflation rate. Regardless of whether you think the CPI-U correctly measures the price level, there’s no way you can correct any inaccuracy by just adding a constant to the rate of change. The numbers produced are barely plausible – they “show” the price level increasing by more than 66% between 2000 and 2006. If you believe that, you’ll believe anything.

  33. Gravatar of MikeDC MikeDC
    7. December 2010 at 17:25

    Rod,
    Yep, slip of the keyboard. My thinking is twofold. The banker needs to safeguard against loss because this time there’s a real chance he might not be bailed out. And there’s still a lot of uncertainty floating around the value of his paper assets.

    Also, the average depositor isn’t paying that much attention, but consider the prevalence of large scale institutional investors for whom formal FDIC insurance means squat. Pension funds and mutual funds, various commercial paper holders and the like.

    I suspect the awareness of the latter players would strongly condition that of the former.

  34. Gravatar of scott sumner scott sumner
    7. December 2010 at 19:47

    Mike DC, No Becker’s not dumb, he’s brilliant. But he’s not a macroeconomist.

    Those structural problems cannot explain the slow NGDP growth and falling inflation, only a demand shortfall can.

    And the markets don’t agree with his argument that we face a long term inflation time bomb. In any case, it would be absurd to argue we should leave millions of people unemployed because of some professor’s highly speculative view that the Fed might do the wrong thing years from now, when the markets now seem unconcerned. That’s precisely the sort of thinking that caused the Great Depression. The conservatives have been wrong about inflation, and they will continue to be wrong, because they don’t understand how modern central banks operate.

    Mike, I could only last through a few minutes of Stiglitz. Up until he started talking about how a $500 billion dollar trade deficit country running “beggar thy neighbor” trade policies.

    Kevin, Posner is a legal scholar, but also a very distinguished economist.

    Greg, Yes, Bernenke has been very unpersuasive.

    James in London, The link you provided suggests America has been running roughly 10% inflation for a decade, on average. And you think I live in an ivory tower?

    Jeff, I don’t agree with the Taylor Rule, I believe in targeting the forecast. And I have done a post responding to Taylor’s view on Friedman. Indeed 4 posts. The one entitled “case closed” (google with money illusion) was the most recent.

  35. Gravatar of Lorenzo from Oz Lorenzo from Oz
    7. December 2010 at 21:40

    The San Francisco Fed seems to have noticed that serious disinflation is happening in the US. The conclusion of the Economic Letter is:
    Both deflationary and disinflationary pressures are relatively large by historical standards. Over a sixth of consumer spending is on goods and services for which prices are declining, while three-fourths is on goods and services for which inflation has slowed. Moreover, the relatively high level of disinflationary pressure is concentrated in the goods and services that make up core inflation. Thus, there seems to be little evidence of any broad-based upward pressures on inflation.

  36. Gravatar of Mark A. Sadowski Mark A. Sadowski
    7. December 2010 at 21:49

    Lorenzo from Oz,
    wrote:
    “The San Francisco Fed seems to have noticed that serious disinflation is happening in the US.”

    What are you suggesting? Only us unrepentant hippies can detect (smell) deflation? Anyone with commonsense can detect it (if they only tried).

  37. Gravatar of Rod Everson Rod Everson
    7. December 2010 at 23:25

    Serious disinflation? You mean a return to relatively stable prices?

    1/6 of goods are going down in price means that the other 5/6 are stable or rising in price. In a perfect world, where the Fed was doing its job, half would be stable to falling and half would be stable to rising. We’re not there yet, but I see no good reason to bemoan the fact that we’re closing in on it.

    Unless, of course, the trend continues and we end in a serious deflation, but who’s to say that’s going to happen (or is already happening)?

    Seriously, if someone described an economy as having stable prices, but a falling real GDP, wouldn’t a rational analysis lead to the conclusion that the monetary authority was doing a good job, but the fiscal/tax/governing authorities were screwing up (or that some external shock had occurred)?

    Hammers looking for nails, I tell you, but the nails are already perfectly driven. It’s the screws that are the problem, or maybe the screwballs that have been trying to run the government the past few years. Bernanke is making a huge mistake pretending that the Fed is capable of righting this mess and it’s going to cost the Fed dearly in time if he’s not careful.

  38. Gravatar of Morgan Warstler Morgan Warstler
    8. December 2010 at 06:40

    Mark, I WANT disinflation, so does the Fed. Opportunistic disinflation was the mission to get down under 2% and stay right about there.

    You are CHEATING.

    You have been saying DEFLATION over and over in this thread. Now you wan to say disinflation.

    Freaking out about a year of .4% is ridiculous. Given the next year is 1.2%. We’re headed int he right direction.

    MEANWHILE, housing prices were truly DEFLATING. And there is a ton of inventory being held off market, so we can expect more. If you had any sense, you’d be cheering for the Great Liquidation in order to bring the money off the sidelines, get 6M houses into the hands of the winners cheap, and let the prices turn around and head the other way.

    Looking at the economics, to me anything that is expected to fall in price is incidental, you either hold it long term, or you get out, refi etc. The main thing is stop viewing your house as a near or mid term investment. If you aren’t buying on the court house steps forget about flipping – hopefully forever.

    Mark,

    Does if bother you that the entire time we’ve seen commodity prices go up, up, up since their lows – end consumer prices haven’t?

    Isn’t that kinda WHY we have this unemployment? To keep making profits companies made every productive cut they could to keep from having prices go up.

  39. Gravatar of Jeff Jeff
    8. December 2010 at 09:57

    Scott wrote:

    Monetarist theory is all about the impact of printing non-interest bearing money–aka “high-powered money.” The reason it’s called high-powered is because it lacks interest, and thus is a sort of “hot potato,” an asset that everyone tries to get rid of, and the in process drives up prices. Milton Friedman and Karl Brunner would be rolling over in their graves if they knew people were claiming monetarist theory meant than the issuance of reserves paying interest at rates higher than earned on T-bills was some sort of “high-powered money.”

    I don’t think this is quite right. “High-powered” money was called that because it took the form of reserves on deposit at the Fed, and thus was available to meet reserve requirements. When excess reserves paid no interest, it was in banks’ interest to lend them out, wherein they would become someone’s deposits, and that part of the new deposits that didn’t become required reserves would again be lent out, and so on, until the original injection of one dollar eventually resulted in (1/r) dollars in new deposits, where r is the marginal reserve requirment. Currently, the reserve requirement is 10 percent, so if all excess reserves were loaned out, a dollar of high-powered money increases deposits by ten dollars. The “money multiplier” is thus 10.

    When excess reserves are not loaned out, however, the money multiplier is only 1. That is, when the Fed buys a T-bill for say, $1000, it pays by check. The seller deposits the check, increasing his money holdings by $1000. His bank turns the check over to the Fed for a $1000 increase in it’s reserve account. These are mostly excess reserves, but because interest is being paid on them, the bank does not lend out the funds. So the total increase in the money supply (deposits plus currency) is just the $1000 that the T-bill seller deposited.

    To coin a phrase, we might say that when the Fed pays interest on reserves, it changes them from being “high-powered money” into “low-powered money”.

  40. Gravatar of Larry Larry
    8. December 2010 at 18:07

    The only interesting critique I’ve heard of QE2 is that the money will leak out of the country and pile up in our trading partner’s reserves without affecting M. Sorry for the poor presentation of the notion.

  41. Gravatar of scott sumner scott sumner
    9. December 2010 at 07:19

    Lorenzo, Thanks for the link. I agree.

    Rod, Even if zero inflation is optimal in the long run, you do not want to reduce the trend rate of inflation from 2% to zero percent right in the midst of the biggest financial crisis in US history, but that’s exactly what the Fed did. Hence near 10% unemployment and massive debt defaults.

    Jeff, I’m confused, in your last sentence you seem to agree with me. So why do you suggest we disagree.

    Larry, Won’t happen, our trading partners don’t hold US dollars, they hold Treasury debt.

  42. Gravatar of Morgan Warstler Morgan Warstler
    9. December 2010 at 08:15

    Mark,

    http://www.bloomberg.com/news/2010-12-09/homes-in-u-s-poised-to-lose-1-7-trillion-in-value-this-year-zillow-says.html

  43. Gravatar of Jeff Jeff
    9. December 2010 at 10:24

    Scott, I just thought your explanation of why reserves were considered “high-powered” needed a bit of fleshing out and contrasting with the IOR situation where banks are content to sit on their excess reserves.

    After I wrote the comment, I Google’d “low-powered money” and found out that some people have used that to mean ordinary deposits. When excess reserves are always lent out, however, that seems to me to be a misnomer, as a non-Fed deposit in some bank means deposits in other banks have to go down by the same amount due to the binding reserve requirements. I’d call that “no-powered” money with a multiplier of 0, while the Fed purchase of a bond under IOR is “low-powered” because the money multiplier is 1.

  44. Gravatar of Mark A. Sadowski Mark A. Sadowski
    9. December 2010 at 23:22

    Morgan,
    I’m an academic guy so I perhaps I don’t eat breath and live commodities like you (or not). Despite the fact you say you’re an IT guy and not a commodities guy obviously you do. Please explain. I’m sure it will be extremely entertaining. (I’m currently looking at all the profits that the producers of commodities are making and the workers they are employing.)
    Mark

  45. Gravatar of Mark A. Sadowski Mark A. Sadowski
    9. December 2010 at 23:38

    Morgan wrote:
    “Isn’t that kinda WHY we have this unemployment? To keep making profits companies made every productive cut they could to keep from having prices go up.”

    Morgan this is totally a**b*ckw*rds. If they could keep their prices steady or raise them things would be different. This is a phenomenon called “price stickiness”.

    Would it kill you to take a course on econ or even read a research paper or two?

  46. Gravatar of scott sumner scott sumner
    11. December 2010 at 15:21

    Morgan, Doesn’t the C-S index show house prices leveling off? They aren’t falling around here.

    Jeff, The multiplier is usually defined as M/MB, in which case it is now near zero.

  47. Gravatar of mark calabria mark calabria
    23. December 2010 at 08:42

    “1. Inflation only seems low because the Fed ignores food and energy.”

    Scott, you’re a smart guy, so I don’t understand your need to distort my views. I do appreciate you providing a link, so that the interested reader can actually see in my piece that nowhere do I say inflation is high. I agree that inflation is low, my point is that low inflation is not the same as deflation. Last time I checked 0.6 and 1.2 are POSITIVE numbers. Our disagreement rather seems to be about the costs of low inflation, not its existence.

    I did enjoy your recent talk in DC, even if I didn’t agree with all of it. Still thoughtful and insightful. I agree that monetary policy was too tight in fall 2008, but this isn’t fall 2008. I would add that a little more modesty on everyone’s part would be in order. At the talk, you clearly had your “all-knowing central planner” hat on. Me, I am just trying to understand the world around me. But I do appreciate you sharing your thoughts with those of us that don’t have all the answers.

  48. Gravatar of Scott Sumner Scott Sumner
    24. December 2010 at 11:57

    Mark, Interpretation is required in any evaluation of another’s statements. For instance, in the talk you attended I said I didn’t trust the Fed to set interest rates and the money supply, and instead favored having the market determine monetary policy. I also said that as long as the Fed was running the show, I’d just as soon they didn’t drive the economy into a ditch with the largest collapse in NGDP since 1938, something you also seem to agree with. You seem to interpret that as me favoring an “all-knowing central planner.”

    In your post you said Bernanke claimed there was no inflation. I assumed you were using that term loosely, as the Fed defines stable prices at 2% inflation. (And I often hear Bernanke complain that inflation has fallen to about 1%.) By that standard, and that standard only, can you claim Bernanke thinks we have “no inflation.” If that’s not right, then you misrepresented Bernanke’s views. If you accept my interpreation then I think you pretty clearly indicated that the claim there was no inflation (i.e. less than 2%–the Fed’s defintion of price stability) was only true if you looked at price indices that exclude food and energy, and not true otherwise. I can’t see any other way to make sense of your post. But that’s not true. I never claimed you thought we had extremely high inflation, I just meant higher than the 2% Fed target.

    This is a long winded answer, but I can’t see how I misrepresented your views unless you misrepresented Bernanke’s views. I gave you the benefit of the doubt, assuming you meant “no inflation” loosely.

    BTW, I think your final paragraph wildly misrepresents Beckworth’s views. There is very little Keynesianism in the views of Beckworth and myself, indeed we are trying to prevent the Keynesian big government solutions (massive fiscal stimulus.) I favor more saving, not less, and more work, not less. Beckworth will have to speak for himself.

    If I did misrepresent your views, I apologize. It was unintentional.

  49. Gravatar of Othon Sofianopoulos Othon Sofianopoulos
    11. January 2011 at 06:21

    http://mises.org/daily/4904

  50. Gravatar of ssumner ssumner
    12. January 2011 at 14:18

    Othon, What’s his strongest argument?

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