Sunday, January 30, 2011

QE2 update

The latest data from the Fed reveals only a modest uptick in the Monetary Base, the measure of that part of the total money supply that is completely controlled by the Fed (bank reserves plus currency in circulation). The uptick to date doesn't yet equal the size of the Fed's QE2 purchases, and the base today is only $40 billion higher than it was at this time last year. Other measures of the money supply (M1, M2) tell a similar story: there has been no unusual growth in the amount of money in the economy. This means that a) a good portion of the Fed's QE2 purchases to date have only served to offset other factors that have subtracted reserves, and b) the extra reserves created by the Fed's QE2 purchases of Treasuries are for the most part still being held voluntarily by banks (i.e., the financial system is still risk-averse enough to want to accumulate safe assets like reserves that pay only 0.25% annual interest). In short, QE2 has not resulted in a flood of new money, but instead has served mainly to satisfy the world's demand for safe haven assets.

It's also the case that one of the stated reasons for doing QE2—to reduce long-term interest rates in order to boost the economy—has at best a mixed record. Treasury bond yields are up sharply since late August when the idea of QE2 was first floated. Yet despite higher bond yields, the economy has picked up and the equity market has enjoyed a substantial rally.

If QE2 hasn't resulted in any new money flows to the economy, and Treasury bond yields are sharply higher, can QE2 still be given credit for somehow stimulating the economy? Perhaps it deserves some credit, if only because it has all but erased investors' fears of deflation, and any reduction of uncertainty improves confidence and that in turn leads to more investment and risk-taking. But perhaps the economy was improving on its own by the time QE2 got underway. Stay tuned as we continue to monitor these important monetary developments.


Benjamin Cole said...

I still fall into the camp that QE2 should be even more aggressive.

The inflation stats out there suggest we are seeing the lowest inflation rates since the Great Depression.

We could even have a spirited debate on whether we are not in fact experiencing deflation--many serious economists believe that various measures of inflation overstate the case. The GDP deflator has us well under one percent inflation for the last 2 1/2 years.

Sometimes the economy has to suffer so we can beat inflation. The Volcker years come to mind.

Now is not one of those times--to fight inflation now is to adopt the Bank of Japan posture for prudent management. Sure, you can keep inflation at zero--but the results are ruinous for the general economy.

Times change, thus tactics change. Yesterday's bogeyman become today's teddy bears, and new uglies raise their heads.

Deflation may the the monster we have to slay now--and make sure we don't do a Japan.

I would rather live through a long boom marked by moderate inflation than a long deflationary perma-recession.

Public Library said...
This comment has been removed by the author.
Public Library said...

You give too much credit to the Fed. We will speak of their blunders in the years to come. It is a matter of time.

Benjamin Cole said...


The GDP deflator for the fourth quarter is about zero.

Where is the frigging inflation?

Bring it on.

Bill said...

I am more in the camp that inflation is now being understated. As was stated recently in an article I read, "there is no inflation as long as you do not eat". Noticeable inflation is occurring in food, gas, other commodities and even now in rents. Some of this is reflation back to earlier price levels but prices are increasing nonetheless. The only place where prices have not yet risen are property prices although this is certainly not far behind in my view.

Remember that the government has a powerful interest in creating and in understating inflation as many transfer payments are indexed to inflation and the government debt is denominated in dollars. I do not trust the government on this one.

brodero said...

I personally believe QE2 is a sideshow...look at corporate bond
yields for direction...

Benjamin Cole said...


Many conservative, non-government economists have looked at inflation stats, and concluded they overstate inflation. Michael Boskin of Stanford is one. The economists at the FOMC (technically, not federal employees) are another group.

In the old days, conservatives used to say the government overstated inflation so that Social Security recepients would get more money, and COLA contracts would bulge, benfitting workers, or other devious liberal agendas.

I find politics clouds everything.

I do think parents trying to get kids through college will feel some inflation. Frankly, I don't know how anyone goes to an expensive private college, with the $200k bill for a BA in XYZ. Dr. Perry over at Carpe Diem has done some interesting posts on the bloating of administrative staffs at colleges.

But in the purely private sector, services and goods just get better and cheaper all the time (one reason to keep 70+ percent of our economy in the private sector).

A cell phone and an Internet connection eliminates the need for a small firm to have a secretary (does anyone even use that word anymore?).

You can download a movie and watch it at home for about 20 percent the cost of going to a theatre, using gasoline, finding parking etc.

The kids have all the music they want for free. I had to buy 12" vinyl discs, and save up to do so.

You used to buy a postage stamp to send a docuement somewhere. Now you can send a PDF instantly, for no marginal cost.

Dr. Perry has charts showing food is a shrinking fraction of living costs--I can remember when families simply did not "eat out." A monthly treat at a Chinese restaurant (less expensive) was it.

Now, people eat out if they feel like it, and sample food from every corner of the earth, and then they complain about inflation? Again, the private sector can truly improve living standards.

Well, I have conflated a few ideas eher but I think th epoint holds: Inflation currently is dead, if you try to look at the big picture.

Benjamin Cole said...

BTW, Scott Sumner has a post today declaring that the "inflation hawks" are wrong, and that QE2 is needed and somewhat successful.

Benjamin Cole said...

BTW, Krugman has a post today relying on some regional Fed bank data. Basically, core inflation is dead, and still headed south. Krugman is not always wrong.

Lori said...

Once again, good stuff, Benjamin!

Removing their dictator aside, there is much talk about the riots in Egypt being related to inflation. Which is pure bull.

In the last 6-12 months, Egyptian politicians have raised TAXES on molasses, cement, steel, cigarettes, air travel, property, taxes on transfer pricing policies.

Raising taxes is not inflation. It is higher taxes.

Lori said...

It is no different in Yemen.

It has nothing to do with inflation.

Raise taxes enough, and people will riot.

Benjamin Cole said...

Well, thanks Lori.

I enjoy your posts as well.

Bill said...

As if on cue:

"'Low' U.S. Inflation Is a Function of Clever Calculation" by John Tamny