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Quantitative Easing

The other day Glenn Beck tried to explain monetary policy.  Here is a better explanation by one of my least favorite Nobel Prize winning economists.  There is an interesting implication here.  Frankly, I’m not even a little bit concerned about the Fed taking a hit.  By the way, the Fed is a private organization despite what Krugman says.  The real thing we should be afraid of I think, is that if the economy does not turn around, then the opposite happens and the Fed gets richer.  That is the Fed ends up owning more and more of the real assets in the economy. 

What’s more, in order to believe that QE can actually “jump-start” the economy and cause interest rates to rise you must believe that interest rates are low due to some defect in the ability of the market to predict the turnaround and the rise in interest rates.  But at the same time, the effect of the QE on the real economy basically works entirely through expectations.  So in other words you pretty much have to believe that increasing the money supply and prices will convince people that the economy is coming back which will make them spend and invest (and more importantly borrow) and this will make the economy come back.  But if beliefs changed instantly in this way they could just say they were going to do the QE and people’s expectations would switch to the positive and interest rates would rise in anticipation of future rises and the economy would heal and no actual QE would be needed.  In other words, to believe in the “jump-start” theory you have to believe that the real economy is based entirely on “animal spirits” and that these spirits are irrational in predictable (and therefore manipulatable) ways.

Here is an alternate theory.  The economy is ultimately based on real factors (a novel concept I know).  People have imperfect information and because of this, monetary policy can distort the economy temporarily but not indefinitely.  Because of the way monetary policy pumps up price bubbles by creates debt, when the economy eventually tries to reset to something that makes sense, it will be extra destructive because of all the defaults that go along with the falling prices and nominal debt. 

If this theory is correct, then QE can hold off the devastating crash by propping up prices.  It does nothing to fix the underlying causes of the crisis though.  Among these causes are the broken monetary system including crushing levels of debt which this perpetuates on an even greater level, high taxes and an overall weak and deteriorating state of the rule of law and property rights.  If people don’t suddenly forget about these things and rediscover an inappropriately optimistic view of the future, then QE will do nothing to suddenly cause robust growth.  If this doesn’t happen, then they won’t be able to get the money back out.  But they will say that this is not a problem. The problem will be that they can’t get enough money in.  They won’t sell the securities back, they will hold them which means they will eventually mature and this will suck even more money out.  They will have to buy more and more assets and the cycle will continue as the Fed’s portfolio gets larger and larger and private (non Fed) wealth gets smaller and smaller.

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