Comments on: QE: Greg Ip answers my questions A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 By: Greycap Tue, 09 Nov 2010 12:10:57 +0000 Very nice explanation by Ip; kudos for him taking the time to write it and you for posting it, Felix.

A few quibbles:

“if it’s targeting, say, a 3% funds rate, it will have to periodically sell, to keep the funds rate from dropping below target”
Now that the Fed pays interest on reserves, this is not exactly true. The Fed will still wish to reduce reserves from time to time but the rate it pays is an effective floor on the fed funds rate.

“If it ever gets long-term rates to where it wants, it will stop buying.”
That’s OK if the Fed frames its target as a rate, but if it announces a quantity (as it has), it must follow through or it will impair its future ability to influence expectations. Remember, the market has already acted on the announcement.

“This is actually a core criticism of QE: that in a liquidity trap, investors don’t really care if they own cash or Treasury bills”
I think that Ip has not given sufficient consideration to this problem. Although you cannot buy real goods directly with T-bills, in the financial markets they are very close money substitutes because they can be posted as collateral. In the repo market they act much like money. Some people with monetarist inclinations, like Gorton, think that there has been a shortage of this collateral-money over the past decade and interpret AAA ABS paper as privately manufactured collateral, needed to satisfy this excess demand. I am skeptical of this interpretation with respect to past events, but obviously it is a logical possibility that at some point the supply of treasuries could be too small to support the repo market. The effect this would have is hard to predict. On one hand, the repo system is the banking system for large depositors who do not have access to insured banking. It fulfills the same valuable economic function that any other banking system does. Yet perhaps impaired access to the repo system would cause corporations to shed as much cash as possible, either in investments or dividends. That might generate the demand the Fed is hoping for. But maybe uninsured deposits in “too big to fail” banks would be seen as close enough substitutes.

By: OnTheTimes Tue, 09 Nov 2010 02:22:06 +0000 It doesn’t matter what you call it, it’s not going to work. There is enough money out there to finance the investment needed to drive a recovery, but the distribution of that money is such that those with it are not interested in using it. If the QE or any monetary policy the government or the Fed implements actually got money in the hands of people who are willing to use it, there would be a chance of a recovery.

All this talk is called re-arranging the deck chairs on the Titanic.

By: trader34342 Tue, 09 Nov 2010 01:46:34 +0000 Well, you’re making the textbook assumption that the government borrows and then spends. But that’s not how it actually works. The government spends the money into existence and then that same money “funds” bond sales. Just think of it logically. If the government doesn’t issue any currency or spend any money then where do the banks get the money to buy the bonds?

The fact is, treasury has to spend the money first and that’s where Ip and most mainstream economists get it wrong.

By: MujiSamovar7 Tue, 09 Nov 2010 01:39:10 +0000 Trader34342,

Doesn’t that ignore that Treasury’s deficit spending is enabled by the Fed’s issuance of Treasuries? Without some issuance, the government is unable to meet its cashflow obligations, and Treasury shuts down. And the bad debt would be written off, thereby “destroying” money, no? Thus, if you follow the chicken or the egg notions here, it is indeed the Fed that’s doing the creating. Treasury is somewhat further down the supply chain, one of a handful (BofA is another player in this example) who are “executing” the money into the economy.

Granted, I guess you’re right in that without a demand for loans, BofA can’t force the money into circulation, and I suppose a contributor to the liquidity trap. Am I missing something from your diddling with semantics?

By: trader34342 Tue, 09 Nov 2010 00:27:57 +0000 Just read this article again. It’s totally 100% wrong. For instance, Greg Ip writes:

“Here’s how QE works. The Fed buys a $100 bond from Bank of America. The bond gets added to the Fed’s assets. Bank of America has an account at the Fed. The Fed, with a keystroke, puts a $100 into B of A’s account. Where did the money come from? Thin air. Bank of America can visit its friendly neighborhood Fed branch and withdraw that $100 in the form of bills and coins. So for practical purposes the distinction between currency and reserves is meaningless; the monetary base includes both.”

No. Where did the original money come from that was invested in the bond? It was already spent into existence by the US treasury. Then Bank of America went out and bought the bond. Then the Fed bought the bond from B of A and credited their reserve account with reserves. It was just an exchange. The Fed didn’t create any new money. The money in circulation wasn’t increased. Ip doesn’t understand how QE works.

By: trader34342 Mon, 08 Nov 2010 23:57:09 +0000 Sorry, my first comment should read that “the Fed does not print new money that goes into the private sector.”

By: trader34342 Mon, 08 Nov 2010 23:47:42 +0000 It’s also important to note that banks do not lend out reserves. This is another notion that Greg gets totally wrong. Banks are never reserve constrained. That’s why adding 1.2 trillion in reserves in QE1 did not result in an explosion in lending. The Fed can add as many reserves as they want. Banks won’t run out and lend them.

By: trader34342 Mon, 08 Nov 2010 23:42:14 +0000 Greg has this wrong. The Fed does not create new financial assets in the private sector. Only treasury does this through deficit spending. Via Warren Mosler:

“When the government “spends,” the Treasury disburses the funds by crediting bank accounts. Settlement involves transferring reserves from the Treasury’s account at the Fed to the recipient’s bank. The resulting increase in the recipient’s deposit account has no corresponding liability in the banking system. This creation is called “vertical,” or exogenous to the banking system. Since there is no corresponding liability in the banking system, this results in an increase of nongovernment net financial assets.

When banks create money by extending credit (loans create deposits), this occurs completely within the banking system and results in a liability for the bank (the deposit) and a corresponding asset (the loan). The customer has an asset (the deposit) and a corresponding liability (the loan). This nets to zero.

Thus vertical money created by the government affects net financial assets and horizontal money created by banks does not, although its use in the economy as productive capital can increase real assets.”

The Fed only changes the composition of already existing assets. Only the US treasury can “print money” through deficit spending. It might sound like semantics, but it most certainly is not.

By: kentropy Mon, 08 Nov 2010 23:10:25 +0000 Props to Greg for noting the distinction between monetary policy that targets liabilities versus rates. This usually gets lost in economic theory as it is taught and used. This paper from the BIS has a nice breakdown of theory versus practice: