The Fed turns on the money spigot again, but will it work?
By D.J. McGuire | Friday, November 5th, 2010 | Policy
The Federal Reserve’s recent decision to throw at least $600 billion into the money supply (dubbed “QE2″ as in the 2nd round of “quantitative easing”) has caused a firestorm around the globe . . . and a debate among economists as to its wisdom. At present, the debate centers on whether the late Milton Friedman, champion of Monetarism, would approve. After examining the arguments, I would say Friedman would oppose it, and so do I.
Interestingly enough, it wasn’t John Taylor or Allan Meltzer (in the Wall Street Journal, albeit behind subscription wall) – both of whom are certain Friedman would have opposed QE2 – who convinced me, but rather (accidentally) David Beckworth, in his attempt to argue Friedman would favor it.
One of Beckworth’s arguments is that Friedman would have reminded us about the entire Monetarist equation that he made famous, namely MV=PQ (for the uninitiated, V is the velocity of money; P is the price level; Q is the level of economic output; and M is, of course, the money supply). Friedman always counseled for a steady rate of money supply growth on the assumption that stability would keep V and P relatively stable, while Q would grow. Beckworth argues that V has not been stable lately, but has fallen during the Great Recession, and thus, Friedman would want that countered with actions such as QE2.
There’s only one problem: Beckworth doesn’t consider why money velocity (V) fell. In fact, his own charts reveal that the decline in V could very well have been in response to the first round of “qualitative easing” (now known as QE1) in 2007-9. In fact, V seems to have levelled off around the end of QE1. This means either (1) given how Beckworth calculated money velocity, it was mathematically too dependent up money growth, meaning his model is flawed, or (2) the American people responded to QE1 not by spending, but by saving/reducing net borrowing, meaning QE2 will have the same effect.
Beckworth might not notice this, but Friedman certainly would have. History has repeatedly shown us that the American people do not respond to temporary fiscal policies (I would submit that half the reason the growth in the “aughts” was so weak and uneven was that the tax cuts that partly fueled them had expiration dates). The Great Recession and Japan’s “lost decade” are evidence that temporary monetary policies have the same impotence.
In other words, it is far more likely that the only effect of “QE2″ is lack of confidence in the dollar, greater concern over the the deficit being “monetized” (i.e., solved by printing money), foreign currencies depreciating in retaliation, and inflation – the very things Friedman opposed during his entire career. This tells me he’d be with Messrs. Taylor and Meltzer (and yours truly) in opposing QE2.
Tags:
Contribute for Conservatism!
Share this post
About the author
Former candidate for Board of Supervisors in Spotsylvania, current blogger, economics teacher, and long-rumored windbag. There are two causes closest to the heart: steering the country away from the social democratic nonsense that is sinking Europe, and convincing the rest of the "rightosphere" that the NBA really is a joy to watch.
Comments
20 Responses to "The Fed turns on the money spigot again, but will it work?"
I’d rather ask the question: “What would Mises do…?”
Depends on what you mean by will it work? Yes, the government will have an easier time paying off its debts because inflation helps the indebted. Yes, the Stock Market will likely take off because some of the money given to the financial institutions will go into investments. Yes, this will be a boon to the Too Big Too Fail banks that make up the Federal Reserve and the international banking system.
For the vast majority of Americans that don’t have large private investments in the stock market or don’t work for large financial institutions this will effectively be a hidden tax as the value of their dollar is further destroyed. The poor and the middle class will be hit the worst by this stealth taxation. The lost purchasing power will be gained by the financial institutions and US Government, making this a transfer of wealth from those with little power to the powerful.
This is not a Democratic or Republican issue. The Federal Reserve has more influence than the House of Representatives, President, or Supreme Court. Which is why its actions were not a large part of any Congressional debate, but its actions will have a larger ramification than the elections last Tuesday.
BEIJING – A senior Chinese foreign affairs official said Friday that the United States should explain its latest round of quantitative easing, urging it to take a responsible attitude as a major reserve currency issuing country.
The US Federal Reserve (Fed) announced Wednesday that it would engage in a second round of quantitative easing, or QE2.
The Fed plans to purchase $600 billion worth of government bonds in a bid to revive the sluggish US economy.
The American central bank hopes this move will ultimately reduce the high unemployment rate that has plagued the economy since its crash two years ago.
This is the second round of such stimulus measures, after the Fed purchased $1.7 trillion worth of mortgage-backed securities and treasury notes between December 2008 and March 2010 aimed to keep the economy from plunging into another Great Depression.
“For the Fed’s new relaxed monetary policy, many countries have expressed worries about what impact it would impose on financial stability,” said Chinese Vice Foreign Minister Cui Tiankai at a news briefing.
“The US new monetary policy will affect not only emerging economies but also developed ones,” Cui said.
Cui’s comment came just ahead of the upcoming Seoul Summit, at which leaders of the G20 countries are expected to discuss a range of issues including trade, currency, financial regulation and reform of the international financial system.
Cui said he believed that the US move would likely lead to “spill-over effects,” which may eventually evolve into “flooding” if not restricted.
The new US monetary move has been widely criticised at home and abroad.
“The Federal Reserve’s proposed policy of quantitative easing is a dangerous gamble with only a small potential upside benefit and substantial risks of creating asset bubbles that could destabilize the global economy,” Harvard University economist Martin Feldstein said in an article published by the Financial Times.
Paul Volcker, former US Federal Reserve chairman and current adviser to US President Barack Obama, called on the G20 leaders to resolve the currency issue at the Seoul Summit, but warned of future inflation due to QE2.
Volcker also said that QE2 would lead to massive capital inflows to emerging markets and create asset bubbles in them.
China maintains that the US loose currency policy will likely saddle China with imported inflation and flood its economy with hot money as foreign capital flows in.
“Macro-economic policy is not just a matter between China and the United States, but also affects the global economy,” said Cui.
“The Fed has the right to make its own decision … but they should not only address their economy, but also take into account the impact on other countries,” said Cui.
While urging the United States to “take a responsible attitude” as a major reserve currency issuing country, Cui quoted financial experts as saying that issuance of banknotes in a reckless manner was in fact a disguised form of currency manipulation.
Analysts said the US move was “logical” as it was striving to ease financial pressure, but emerging economies like China and Brazil should now gear up for an influx of capital.
“It is the US decision-maker’s logic to buy financial assets through issuing more currency in a bid to help financial institutions and companies,” said Li Daokui, a financial expert with Tsinghua University.
Li said the most urgent need now is to prevent the flow of cross-border “hot money” from impacting on the economy.
“The United States was sick but the other countries had to pay for the medicine,” said Zhou Shijian, an American studies expert with Tsinghua University, adding that China is the biggest victim of the new US fiscal policy among the emerging economies.
“The United States is doing something that benefits itself at the cost of others,” said Zhou.”
http://www.chinadaily.com.cn/world/2010-11/05/content_11510108.htm
Since the election is over, it is time for this “gringo” to fly to South America. The value of the dollar will take on a personal meaning then.
[...] Cross-posted to BD [...]
DJ – Forget about V. It’s irrelevant and distracts from the bigger questions … What are the risks of QE2 working?
Friedman’s version of Quantitative Theory can’t be viewed in a vacuum. It was developed during the hotly debated arguments of the 60s and 70s regarding how to best combat inflation. To make his case against the prevailing mainstream view of the time (cooperation btw. business & labor, anti-trust policies, and/or wage & price controls were the best actions to combat inflation), Freidman and monetarists collected data (from the 50s and early 60s) to argue that the Fed’s manipulation of interest rates caused destabilizing fluctuations in money supply growth – which led to economic downturn (caused by inflation). Monetarists also argued that the lag time between assessment (of economic conditions) and effects (of policy actions) made Fed attempts at ‘fine tuning’ a balance between inflation and unemployment efforts in futility. They argued instead for a policy that kept the money stock at a low, fixed rate – ignoring irregular up/down moments in economic activity.
I think Freidman’s late in life interviews reveal a great deal about what he might think of the Fed’s actions: In 1992 he said the one unsolved economic problem of the day was – how to get rid of the Fed (or replace it with a computer). And then later, ” I do not agree with the view of the 100 economists calling for increased spending to spur economic growth. My disagreement is partly based on political considerations, partly on economic considerations. From the political point of view, increased spending may initially be designed to be temporary but few things become more permanent than temporary spending. Hence, the economists are in fact calling for a still higher level of government spending yet, in my view, reducing the scope of government is our most important single objective.” And then in 2000: “If you look over the record of the Federal Reserve over its whole history, its done harm more often than its done good.”
The Fed’s intent with QE2 is to avert DEflation (falling prices) by debasing the dollar.
I am not an economist, but I have heard some talk on this subject.
What I am wondering is that if China is going to artificially keep their currency low, what is wrong with flooding them with dollars?
What I am thinking is that if China continues to insist on a weak currency, we keep printing dollars to send over there until they wake up.
A currency war? Well, there is nothing wrong with self defense when others fire the first shot.
David,
The way this is being done will hurt the poor and middle class before it hurts China. QE2 will be handled by financial institutions that will likley by up stocks, allowing the stock market to rise. It will also devalue our currency. For the top percent of the people who are heavily invested in the stock market this will act ot either meet parity or to find some profit. It will also enable the government to more easily pay off its debt.
For the rest of the economy, the devaluing of our dollars will act as a hidden tax. Energy and food prices will rise in comparison to monthly income, impacting the poorest the most. As for people on social security, the amount of dollars won’t change but that social security check won’t go as far as it used to.
Quantitative Easing, also known as the printing of money, hurts the general population the most while aiding our political and financial class. It acts as a transfer of wealth from the general population to the power elite.
Obama a Socialist? No, he’s worse than that, and calling him a Socialist plays into his hand and blinds his followers that believe him to be a modern day Robin Hood. Obama is a Corporatist, and represents the financial institutions. Watch his actions instead of hearing his words.
The Fed’s intent with QE2 is to avert DEflation (falling prices) by debasing the dollar.
“Intended or not, the Fed’s destruction of the dollar’s value has pushed prices of commodities that Americans need — such as instance food, cotton and oil — higher.”
http://www.dailyfinance.com/story/fed-policy-sinks-dollar-commodity-prices-soar/19701878/
“Maybe all the financial speculation enabled by the Fed’s easy money, zero-interest rate policy (ZIRP) easing will enrich a few trading desks and hedge funds, but the price increases triggered by the Fed’s policy will certainly reduce the net income of every American household as prices for essentials climb.
If you have any doubts about that, just take another look at those charts of cotton, sugar and grain.”
The chart of look like fake “global warming” hockey stick.
I went thru this before with Jimmy Carter. Its called stagflation.
The chart of cotton looks like fake “global warming” hockey stick.
James, last time easy money went into commodities we had a spike on oil and the price of food. This caused hunger riots in many places of the 3rd World. The actions of the Federal Reserve is not only a danger for our own economy, but one that can effect the global economy in a negative way. I believe we are seeing a re-inflating of food commodities, and if so we are going to see worse food riots than before in the 3rd World since many countries still have not had time to recover from the last food commodities incident.
A devalued dollar theoretically helps grow GDP by boosting US exports. As the dollar’s value drops, emerging markets (offering higher yields) are flooded with US dollars, leading to more emerging market economic expansion, leading to higher personal incomes, leading to greater demand for US goods. Plus as the dollar falls, US exports become more price competitive worldwide (in theory).
Exports, however, account for barely 12% of our GDP (compared to 50% for Germany, 212% for Hong Kong/China, 80% Ireland, 28% Mexico, 35% Canada, 24% India …). A weak dollar will hurt Europe, Asia, and other global players – likely more than it will help the US economy. Plus, the model tells us nothing about what other countries will do, in reaction to Fed policy. Hence, the major grumbling and push backs from abroad. http://www.washingtonpost.com/wp-dyn/content/article/2010/11/05/AR2010110507115.html
@ James – you’ve probably already noticed the banks’ immediate reaction to QE2 – a move to increase shareholder value. http://online.wsj.com/article/SB10001424052748703805704575594650694019436.html
Using non-emperical economic theory to make policy (applied economics) is risky. You can fill your models and forms with content, but if the content is ‘off’, intended outcome gets flushed. Economic theory is logical, but it’s abstract and extremely vulnerable to impact of competing policy decisions (i.e. Commerce’s recent proposals to strengthen enforcement of US trade laws – which may cause exporters to face similar toughened up trade policies in partner countries, thus applying negative pressure on potential positives of QE2).
The more interesting questions are:
- When will businesses begin hiring again?
- What will be the global markets’ response to QE2?
- And how will that response impact US economic recovery?
QE2 is starting to look like a hidden VAT tax on the American people.
Thanks for the links Jay D. Last dividend check from my largest bank holding went up about 20%. However since the bank lowered it by 75% to start with, I need a 200% increase just to get back to where it was a couple of years ago.
@James- not sure I would take it that far
(hidden VAT tax). But yes; when the dollar’s value drops and prices rise (goal of QE2), consumer paychecks don’t go as far and consumer savings is worth less. If you can’t equalize the loss with other gains (stock market, higher wages, etc.) … yeah, you get hosed by QE2. On the other hand, devalued money means you get to payoff dept (or acquire new debt) at a lower cost. QE2 outcomes reward debt and discourage savings.
The bipartisan deficit reduction commission seems to have independent, republican and democratic politicians in Washington,DC screaming !!!!!
That in of itself might the best reason to support it.
To stop the slow motion train wreck of deficit spending means pain. A program that gets everyone in this country including myself enraged at our politicians is what will be necessary. Everyone will feel pain to get out of our current mess.
Embarrassment in Seoul
http://online.wsj.com/article/SB10001424052748704462704575609770024501384.html?mod=rss_opinion_main
“Only the Obama Administration is determined to keep both the fiscal and monetary spigots wide open, while blaming everyone else for the poor domestic results.”
Oh just great, the entire world is doing the exact opposite of current federal policy. George Soros is betting on a U.S. financial collapse and moving assets to gold and to the emerging economies. Having some of your IRA assets in gold and/or emerging markets might be financially lucrative.
James Hawkins ~ Thanks for the link. Here’s an interesting back-story article; Geitner is not in friendly territory right now. Maybe payback opportunity for IMF is in the room?
http://www.smh.com.au/opinion/obamas-economic-saviour-savaged-as-keating-lets-rip-20090306-8rk7.html
Thanks for your link Jay D. As I was roaming, found this comment “Well, I can understand that the world can see that Obama’s fiscal polices are beyond belief. It’s not just him, but the problem is much worse. The problem is that what we are doing is worse than what we were doing! GOOGLE “Quantitative Easing Explained and How We Got Here” Watch the little video. It extually explains it very well.”
http://www.youtube.com/watch?v=PTUY16CkS-k
“how is putting in charge the same fool who has been wrong about everything the change ? Is this some kind of nightmare?”
The “dot-com bubble” was a speculative bubble covering roughly 1995–2000 (with a climax on March 10, 2000 with the NASDAQ peaking at 5132.52 in intraday trading before closing at 5048.62) during which stock markets in industrialized nations saw their equity value rise rapidly from growth in the more recent Internet sector and related fields.
Some believe the crash of the dot-com bubble metastatized into the housing bubble in the U.S.
However, the housing bubble transformed into the current full scale subprime mortgage crisis which started in late 2007.
I wonder what the next bubble will be? And the next crisis?
[...] Lightroom, Storage Space, and Big Catalogs | Adobe Photoshop Lightroom Killer Tips The Fed turns on the money spigot again, but will it work? : Bearing Drift: Virginia Politics On De… Golden Valley man shoots barking dog, asks, “What was I supposed to do, call animal [...]
Leave your response
The comments section is for meaningful discussion. Readers are reminded to post comments that are germane to the article and write in a common language that steers clear of personal attacks and/or vulgarities.
Please take a moment to review our comment policy.