Home > Economics - General > QE2 — Crooked Timber

QE2 — Crooked Timber

November 4th, 2010

The US Federal Reserve has announced its long-awaited renewal of quantitative easing (cutely labelled QE2). It’s $600 billion of new money to buy US Treasury notes with an average duration of five years, along with recycling of some money from the mortgage bailouts, also into T-note purchases. That sounds like a lot, but the reaction from Brad DeLong (endorsed by Paul Krugman) has been a big yawn. With the five-year bond rate at just over 1 per cent, the amount the private sector would demand to hold these bonds (that is, the annual interest payment) is about $7 billion, which is rounding error in the context of the current crisis.

I had been thinking that the Fed might take the much riskier (and politically trickier) step of buying corporate bonds. That would seem more likely to promote investment, but would obviously involve a good deal of winner-picking, with the associated potential for (real or perceived) corruption.

But what is really needed here is fiscal stimulus focused on job creation, combined with a long-term plan for fiscal consolidation (that is, higher taxes and/or lower expenditure). Instead, what the US appears likely to get is a permanent tax cut for the rich, partly offset by lots of job-destroying nickel-and-dime cuts in current expenditure. Many of these cuts will prove to be counterproductive or unsustainable in the long run.

Posted via email from John’s posterous

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  1. Nick R
    November 4th, 2010 at 22:16 | #1

    Macro is not my area, but I have wondered if it could be a good idea for the Fed to simply announce that it will err on the side of caution with respect to raising interest rates when monetary policy begins to gain traction. Given the amount of liquidity floating around, inflation could spike when banks begin lending again. If the Fed indicates it will be slow(ish) to raise rates, it should raise expected inflation and reduce real rates.

    This seems to me to be more politically feasible than announcing a higher inflation target.

  2. Sam
    November 5th, 2010 at 13:16 | #2

    Hi Nick R, that’s pretty much exactly what Krugman is saying here.

    I have to say, though I know all about the political problems, I genuinely don’t understand the economic arguments against really massive QE2 in the current situation. Both Krugman and Quiggin focus only on it’s effect on the money supply. Surely there is a huge, costless, taxless, fiscal benefit as well? Surely now is the time to be as irresponsible as possible?

    It’s quite likely I’m missing something. Could someone please explain to me why a sensible federal government couldn’t just cut all taxes to zero and finance the whole budget by printing money (or, in the context of QE2 issue government bonds and have the central bank buy them back with self-created fiat currency)? I mean, if the only possible bad effect is inflation, and if right now we want inflation, what’s the problem?

  3. Ikonoclast
    November 5th, 2010 at 14:38 | #3

    Right now, the USA needs fiscal stimulus and higher taxes on the upper middle, rich, corporations. It also needs job creation social employment and capital works plus more regulation of the finance system. It will get none of this, ever. The plutocrats won’t let it happen, ever. So watch the USA spiral down and down indefinitely.

  4. stockingrate
    November 5th, 2010 at 22:07 | #4

    The USA is in secular decline as information flows have allowed competition from China, Japan and Korea. Stimulus intended to be counter cyclical is wasteful the problem is secular not cyclical.

  5. Alice
    November 6th, 2010 at 08:06 | #5

    Agree Ikono – the only wasteful think is the quantitative easings which are not working. You can lead people to cheap loans with lower interest rates but you cant make them borrow when they dont have a job or when they are grimly hanging on to existing debt worth more than their house would sell for. Japan tried this and failed dismally after its property bubble burst. Its a liquidity trap.

  6. sdfc
    November 6th, 2010 at 20:42 | #6

    I agree Stockingrate the US is in decline. However letting a high debt economy fall into deflation could be a disaster.

    I’m not really a big fan of QE2, already the 30-year bond rate is rising and putting upward pressure on mortgage rates. I can understand why emerging market monetary authorities are getting a little toey.

  7. November 8th, 2010 at 18:59 | #7

    Part of the intent of this money creation exercise is to cheat the Chinese (and national and other international borrowers) of the debt the US owns them. It used analogous techniques after the Vietnam War.

    The US will gradually force international inflation to help reduce its public indebtedness. If China seeks to maintain the RMB peg against the US dollar this will be easy and the US knows there are significant reasons for China to continue to do this rather than to allow an appreciation.

    The US wants to force the Chinese economy to restructure when the real structural problems are in the US. A grossly bloated financial sector, a hollowed out manufacturing base, an economy which outspources most production and sees marketing effort as a major productive activity, low savings etc etc. – a spiv economy – in short.

    The Republican ascendancy exploit economics of scope in producing delusions – in promoting free market fundamentalism, in denying climate change, in fostering creationist views of the origin of species. The latest delusion is that the problems of the spiv economy can all be traced to poor Chinese who save too much.

    Expropriation of the hard-earned Chinese assets rather than a long-term plan to raise US taxes so the public sector can pay for itself is another of the latest delusions.

  8. Alice
    November 8th, 2010 at 21:31 | #8

    hc – couldnt agree more – the US is a spiv economy indeed. But they followed their own bad advice and went headlong down global road – and of course deindustrialised themselves because consuming is their comparative advantage, not producing. Trouble is their comparative advantage isnt sustainable and I bet a lot of countries comparative advantages arent sustainable either when they end up relying on a few meagre global specialties to put food on the national table.
    This globalisation fad and its ridiculous underpinning theories was really a load of garbage wasnt it? One of the worst shams of all time.

  9. Jimbo
    November 12th, 2010 at 06:57 | #9

    One factor I believe that didn’t get enough attention during the crisis is the problem of stagnant wage growth in the US. Over the last 30 years, real wages have remained more or less the same. The result of this is that many households have resorted to borrowing in order to maintain their material standard of living – leading to an explosion in private debt levels.

    A second is the horrendous fiscal mismanagement of the Reagan and GWB administrations. Essentially they hollowed out the tax base (with the benefits primarily going to high income earners), without making the necessary spending cuts to compensate. This today leaves the US in the situation where it must seriously weigh up any further Keynesian stimulus package, as eventually it will have to reign in its huge deficit, as the UK is beginning to do – but the risk of this is that it will further depress economic activity, and see a double dip recession.

    This was essentially a demand fuelled crisis. As we have seen, there is a limit to the extent to which the working class can borrow to finance expenditure. Combine this with stagnant average wages, eventually you will get a situation where there is simply insufficient demand to support domestic employment. QE2 is probably ultimately a necessary step in injecting liquidity and inflating them out of the debt bubble, but it does little to address the underlying factors of the crisis, and will inevitably cost the US in terms of destroying the primacy of the dollar.

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