By Dan Kervick
The Fed did something on Wednesday: it announced a new program of open-ended quantitative easing, and it announced that it likely won’t pull back on the new round of monthly asset purchases once the economy begins to recover more strongly, but will keep the purchases going for some indefinite period of time afterward. After what exactly was left unsaid. The Fed apparently has a target it intends to overshoot, but hasn’t said exactly what the target is. But whatever it is, we have been given forward guidance that the reaching of that unspecified target won’t stop the asset purchases – at least not right away.
This announcement has greatly pleased all of those people who have been calling for the Fed to do something. Critics of Ben Bernanke have been deeply frustrated by the terrible lack of somethings emanating from the Fed. If only something would be done, the economy would grow and jobs would come back. The economy has been suffering from a something deficit! Where is the doing that needs to be done?
Well something has now been done. Hallelujah. And many of Bernanke’s critics appear to have undergone a religious experience as a result. Bernanke has been transfigured in their eyes from diffident nebbish into brave something-doer: an explorer of uncharted monetary territory boldly doing where no Fed has done before. So the doing has been done – and it’s really something, isn’t it?
Yet when one reads accounts of how these asset purchases are supposed to accomplish their aim of generating a stronger recovery, one gets a lot of conflicting theories. It’s almost as though the mere doing of something – anything – is thought to be more important than the actual nature of the something that is done. But there is a common core running through most of these explanatory accounts: expectations. The economic policy globe, it seems, turns upon the axis of our expectations, and the Fed is the master of those expectations.
Here’s how it works in theory: Suppose there is something X the Fed would like to see happen. The Fed is supposed to make X happen by announcing that it intends to make X happen and that it is doing some other thing Y that is aimed at making X happen. The hope is then that a significant number of people think that there is a causal connection between Y and X, and that Y causes X. They thus start to believe, on the basis of the announcement, that Y will in fact make X happen. And as a result of these beliefs, they then start to behave in ways that depend on the expectation that X will happen. And it is their behaving this way that in the end actually makes X happen – if the trick works.
So what is important, the defenders of this approach say, is that people believe quantitative easing will cause a stronger recovery. They will then start to invest in production, hiring and consumption more readily because they are expecting improved conditions. And by doing these things, people will actually generate the desired stronger recovery. It doesn’t really matter what quantitative easing would have accomplished on its own if people didn’t have these beliefs.
If this approach to governing a society seems strongly familiar to you, that’s because it is an ancient one. It is the way some shamans operate.
The shaman, let’s say, wants the people to plant more crops and work harder in the fields to make the crops grow. So the shaman does a fertility dance to petition the fertility goddess for her favors. The people believe the fertility dance will make the crops grow. They get excited, and start planting with more alacrity. They also work extra hard and put in longer hours in the fields because they now believe the fertility goddess is on their side. And the crops grow! The dance worked; the prayers have been answered. The shaman might believe in his own magic; or he might be a manipulative cynic. It doesn’t matter. The desired outcome occurs either way.
Notice that the effectiveness of shamanistic economics, if and when it is effective, does not depend on what X and Y are. They could be almost anything. It could be that X is a reduction in the unemployment rate and Y is a program of Fed asset purchases. Or it could be that X is an increase in iPad sales and Y is an auction of relics from Steve Jobs’s house. All that matters is that apart from whatever actual causal connections exist between X and Y that operate independently of expectations, there are also a lot of popular beliefs about the connection between X and Y that cause people to act with the expectation that Y will cause X.
Shamanistic economics, when it becomes a routine way of life, debases and undermines our democracy. Its continued efficacy depends on the perpetuation of false and superstitious beliefs among the public, which corrupt public understanding and the capacity for rational public deliberation. It also encourages, and even depends to some extent for its operation, on an attitude of deferential awe toward the central bank and its leadership. And it encourages policy makers themselves to adopt an operating stance of aloof and frequently deceitful control of the masses, rather than a posture of open and accountable public service to the citizenry. The shamanistic policy maker is not a public servant; he is a magus.
It seems deplorable that professional economists are willing to participate in this antithesis of democracy, and replace informed democratic self-government with a primitive and archaic form of governance. To be fair, some of the people calling for more quantitative easing have offered defenses of the program that depend on more firmly grounded and resilient causal mechanisms – non-shamanistic mechanisms that do not depend on the fickle vacillations of popular beliefs and delusions. And even some of those calling for quantitative easing based on the shamanistic path aren’t arguing for the employment of shamanistic economics all the time. Instead, they just seem desperate. They would prefer more concrete actions from the US Congress, but believe it is impossible to get Congress to act. It’s hard to blame them in their despair. The current Congress is one of the most incompetent, malevolent and cynical groups we have ever had sitting in Washington. And the President, with his misguided emphasis on long term deficit and debt reduction hasn’t been that much better – although he has called for more spending up front, with the deficit reduction to be put off until later.
But there are other people – for some reason more prominent in the blogosphere than elsewhere – who defend full-bore shamanistic economics as the preferred way of doing the country’s macroeconomic policy business all the time. They believe the Fed should steer, direct or conduct the economy, playing the expectations of the frequently deluded and grossly untutored masses like an instrument, and managing all with its fertility dances and awe-inspiring pyrotechnics. A certain kind of mind seems drawn to the shamanistic approach. They seem to be mostly white; mostly male; mostly young; mostly college educated. They don’t seem to like democracy very much – and the fact that the shamanistic system keeps politicians and citizens out of the picture, and concentrates power in the central bank and the major financial institutions it coordinates and conspires with, is appealing to them.
There is an alternative version of the expectations model of Fed policy that some would say excuses the expectations-oriented macroeconomist from the charge of shamanism. On this view, we are to imagine the world consisting entirely of a thought leader surrounded by people who watch and listen to everything the thought leader does and says, and who form their expectations accordingly. They all know that everyone else is watching and listening to the thought leader, and is also forming their expectations in accordance with the leader’s powerful words. But since they all know these facts about how they and their companions are forming their expectations, then when they do change their expectations of the future in response to the thought leader’s statements, they are behaving rationally. Mass conformity, coupled with mass knowledge of mass conformity, renders the expectation of continued conformity rational. It’s not magical or superstitious at all.
How delightfully clever!
But here is the problem with the applicability of this philosophical thought experiment. In the real world, very few people are really paying much attention to the Fed and its illustrious Chairman, much less forming their expectations in the light of his words. If you work in an ordinary place of business, filled with a broad cross section of folks, try asking a few random co-workers what they thought of Ben Bernanke’s press release or press conference on Wednesday. And for those among them who listened, and can say something non-vague about it, go on to ask them how they are changing their behavior in response.
What the popularity of this cramped expectations conformity model among some economists really shows is that the people who are attracted to it believe that the Fed guides the economy because it guides the actions of the only people who matter – the big players in the asset markets, who hang on the central bank’s every statement, whose moving and shakings shape the world, and whose profits then trickle down on the rest of us. It’s a top-down view of economic reality. These financial and asset market giants are the true masters of the universe. (They are also often the guys the shamanists went to college with.) Macroeconomic policy should be geared toward feeding them with profits and keeping them happy, not toward building an economy from the ground up. Boost big finance, keep the meddling masses out of the decision-making, and let some of the overflow trickle down.
Will quantitative easing work? I’m skeptical. But who can say for sure? Perhaps business people are excited enough by Bernanke’s fertility dance to start planting their economic fields again and begin investing more heavily in work and production. Maybe there are enough suckers believers out there to drive the economy forward with their new zeal over this confusing Fed something. Or maybe we’ll just get a brief asset rally followed by nothing – or even another dangerous and unproductive bubble blown up by short-term profit seekers who will accelerate the QE hype just long enough to make a buck for themselves before cashing out.
But if the expectations magic does work a bit that is in itself worrisome. The continued practice, and occasional success, of shamanistic economics will add to the vanity of the elites who are drawn to this way of thinking about macroeconomic governance. They will argue for even more transfers of economic policy power away from the elected, political branches of government to the central bank. They will be more convinced than ever before that they are in the possession of special magical powers or wisdom, and even more strongly convinced of their divine right to govern. They will redouble their commitment to top-down, plutocratic economic governance. And transitory successes in shamanistic economics will increase the superstitious tendencies and political passivity of others who don’t know any better, and who assume that the elites always know best.
You can follow me on Twitter @DanMKervick.
This was an absolutely fabulous post! I will definitely send around. Everything you did to describe monetarism – from the hilariousness term “Shamanistic Economics”, the explanation of how the expectations game is supposed to work, to the corrosive impact on democracy – was fantastic.
Brilliant post – absolutely spot on.
I actually feel a bit sorry for Bernanke, he looks exasperated. Reading between the lines of what he said, he knows quite well this is all about trying to summon up the Confidence Fairy (all that stuff about ‘communications’ being one of the Fed’s key tools). Someone actually made a valid point at the press conference along the lines of doesn’t he worry that while he ‘appears’ to be doing something, those who actually can do something (i.e. Congress), won’t.
QE1, 2, 3, 4 won’t work in any positive way for Main St.
When the GFC hit Australia the government quickly took four major action
1. It guaranteed all bank deposits.
2. It paid all on social security and low incomes an extra $900 as a one off payment just before Christmas.
3. It provided substantial funds for capital works improvement for all schools
4. It instituted a home insulation subsidy program.
The insulation program was found to be poorly run by some state governments and was terminated early but a recent study has shown that the cost is being quickly being exceeded by savings in heating and cooling costs. A large proportion of the Australian population live in areas where little heating is required.
The schools program has meant that most schools now have excellent libraries and many other improved facilities. And, although Australia has benefited more than most from the booming demand by China for raw materials our bank’s activities and the earlier housing boom would have lead to trouble had the Federal Parliament not acted as it did. One unfortunate result has been that the banks escaped the consequences of their earlier stupidity.
Dan, am trying to come up with a bit of an analogy, not sure if I’m on the right track with the following –
The neo farmers continued to be perplexed by the repeated poor harvests, after all, they had made a manure tower 200 meters tall, but the surrounding feilds refused to co-operate by producing anything approaching a decent crop. So they decided to add another 100m to the pile, surely that would convince the fields to grow.
Sure, there is tiny group of modern manure theory farmers, who keep suggesting spreading out just a fraction of the pile all over the feilds would do wonders, but what would they know, haven’t they read the manureism textbooks…
Seems like a pretty good analogy to me Hamish. A lot of folks keep calling for the Fed to “print money and buy stuff”. But it would be better for the government as a whole to be “printing” money to buy industrial output and labor services, than just to buy more financial assets. Just as good maybe – tell every American adult they are going to get a $100 check each month, and that the program will be continued indefinitely. All they have to do in return to get the check is bring their most worthless and unwanted household item each month to a government warehouse – their “toxic assets” so to speak. The program would cost about the same as the Fed program and have, I believe, more effect.
For QE to work, it requires a credible transmisison mechanism, which it doesn’t have. Even the ‘heretics’ at St Louis Fed are now proclaiming the ‘interest rate channel of monetary policy’ dead. The interest rate channel!! Of monetary policy!! And that QE/ZIRP is more an economic hindrance (see earlier post at MNE). It’s a bit like a dept head noting that his best salesman has a lofty entertainment account, and therefore gives his entire team a larger entertainment budget to fill because it will supposedly increase sales, but is then surprised when it does no such thing. The connection betwen the action and the goal is being repeatedly missed here.
Bernanke seems also to think (see Q&A) that a wealth effect at this stage of the game works exactly the same as it did in 2006. For a supposed learned economist (he’s not alone), this ‘linearity’ of expectation, or response, is mind-numbingly obtuse. What they need is an ‘adaptation model’, not an expectations one that is hard-coded. This is also the reason NGDP targeting is such an ordinary idea. What growth/inflation mix is it targeting anyway? Which inflation measure? Does hitting the target (accidentally, if ever) mean success, or is the mix somewhat toxic? Goodness.
Could you kindly explain what will definately work instead. Like Land Value Taxation, for example! (see http://www.progress.org and its many links.)
My preference: Congress writes and passes a law directing the Fed to credit a trillion dollars to the Treasury account. Congress spends the money on various major programs that put unemployed Americans to work. No new taxes, and the government doesn’t issue more debt and so doesn’t freak out the debt hawks.
The problem is that every (false) green shoot from now on will be seen as “evidence” that the policy is “working.”
And maybe it will work. Or maybe it won’t. Who knows? Lots of companies have lots of money that they aren’t spending. Maybe this time the confidence fairies will really wake up. Just because shamanistic economics is a long-term threat to democracy doesn’t mean that it can’t produce positive short-run psychological effects. The policy is all based on trying to harness the unpredictable mojo of market exuberance.
Why would any company invest based on expectations when customers are not there? And if they did they would have even more unused capacity. Consumers follow even less what Fed does to manage our expectations and are busy repairing their balance sheets. They won’t consume more until they feel they have paid debts down sufficiently enough.
Danger with this expectations theory is that if economy improves for any reason when Fed is doing it’s tricks we learn the wrong lesson: expectations theory works! No need for fiscal stimulus just manipulate expectations that will be enough. More voodoo!
Talk about hitting the nail on the head. Hell, this piece could summarize economic policies for past several decades. Markets rule, our new gods and high priest.
There’s a name for this: Plutonomics.
“Plutonomy: Economic growth that is powered and consumed by the wealthiest upper class of society. Plutonomy refers to a society where the majority of the wealth is controlled by an ever-shrinking minority; as such, the economic growth of that society becomes dependent on the fortunes of that same wealthy minority.” (Investopedia dictionary)
Yep! And a lot of academic economics – and the culture of elite educational institutions – is organized around the imperative of preserving the plutonomic power structure, even if that ideological defense of the established order is dressed up in the garb of economic efficiency and the public interest.
The price of oil is up again. QE3 seems to be having an impact.
The only reason I would like to see Romney get elected is to see a President sack a Fed chairman and replace him. People might then realise that the Fed is a tool of the government and just does what the government wants or allows it to do.
Yes, great post.
And it’s sad to watch rational people like Krugman falling for this kind of claptrap.
If the best that mainstream economics has to offer is a form of voodoo then it’s hard to imagine our great leaders, who are entirely captured by its spell, finding a way out of the present predicament.
At core I suppose it is a pagan / anti-human worldview they possess Dan…
Good stuff! Rsp
Shamanomics. Paganomics. No wonder these pagan shamans used to worship gold.
Dan, the thing is that the supporters of this policy really do believe that the Fed has real transmission mechanisms. If that is true, then playing with expectations doesn’t debase democracy in the duplicitous manner you describe. It’s like the Fed announcing changes to the FFR- they don’t really need to take action, because they have a credible transmission mechanism. The problem is, of course, does the transmission mechanism really exist, and do people care enough for expectations to be fulfilled?
Yes, I guess we’ll learn something from this experiment about whether there is an effect. But it might difficult to separate out effects driven by mechanisms that are unrelated to expectations and effects driven by expectations alone.
This is true.
Hit the nail on the head. At least ‘doing something’, even if it isn’t the best thing, provides some counter to doing nothing, or something actually harmful, which would be the GOP approach. And, it might open up the conversation a bit more about ‘doing something’ else. I agree about Congress. Hard to have any optimism.
Yes, I’m not arguing this step will be positively harmful. But the time, intellectual energy and verbal energy spent on policy debates is a kind of capital. If it is invested in one area of debate, it will not be invested in some other area of debate. The economic blogosphere has invested an incredible amount of intellectual capital over the past two years in central bank policy, and in advocacy of psychologically iffy changes in Fed expectation management regimes. I believe that capital would have been better invested elsewhere, and that the focus on Congress would not be a pre-determined lost cause if prominent voices had decided to attack that policy front with the same gusto as the attacks they have launched on the Fed front.
Bernanke hinted pretty strongly in his testimony that he would like to see spending on the fiscal side. He also discussed the fiscal cliff pretty directly. It’s better than ducking and covering.
This is part of what I mean when I say I hope it opens up the discussion at least a crack.
Very interesting post!
I believe there are analytically two components to this view of the Fed as a economic shaman:
1) Is our economic policy guided by the best social and natural science? The connotation of a shamanistic view is that it is instead guided by superstition
2) Even if it were guided by the best social and natural science (which it isn’t), can central banks and treasury departments apply tools that have direct, clear impacts on the economy as a whole or are the effects “chaotic” and/or mediated by the subjectivities of private economic actors (i.e. expectations, capital strikes, etc.)
MMT and post-Keynesian economics provide governments with much better tools to manage the economy and also offers tools like the job guarantee and fiscal policy guided by concrete “real economy” objectives that will in fact have clear effects. However, as Kalecki pointed out 70 years ago, there are political conflicts involved in taking the whims of private market decision makers out of the business of determining whether or not we should have full employment or other social goals.
It seems to me that the policies that should be pursued are those that rely on the least amount of subjectivity and that eliminate guesswork and contingencies as far as possible. If the government directly hires people to do valuable productive work, for example, the people who are newly hired don’t have to have the expectation they will have higher income or the confidence that they will have higher income – instead they will actually have higher income. They will go into stores and try to buy the things they have wanted for four years but couldn’t afford. The people who own those stores will produce more products, or order more products from the producers who supply them. They won’t need expectations of new customers or confidence in the existence of new customers. They will have actual new customers with cash in hand.
Shamans are honest. For instance, read this exchange between a rain doctor and a medical doctor:
“Medical Doctor [i.e. Livingstone]: So you really believe that you can command the clouds? I think that can be done by God alone.
Rain Doctor: We both believe the very same thing. It is God that makes the rain, but I pray to him by means of these medicines, and, the rain coming, of course it is then mine.
Medical Doctor: I only think you are mistaken in saying that you have medicines which can influence the rain at all.
Rain Doctor: That’s just the way people speak when they talk on a subject of which they have no knowledge. When first we opened our eyes, we found our forefathers making rain, and we follow in their footsteps. You, who send to Kuruman for corn, and irrigate your garden, may do without rain, we cannot manage in that way”. (Cited in J. & J. Comaroff: Of Revelation and Revolution: Christianity, Colonialism, and Consciousness in South Africa, The University of Chicago Press, 1991, p. 210-211)”
For more, check http://xyz4000.wordpress.com/2011/03/01/is-rain-dance-superstitious%E2%80%94willem-derde/
The problem with the mainstream economics is this. Their research program is degenerative, a Lakatosian concept. The explanations they come up with to account for empirical anomalies constitute the protective belt (another Lakatosian concept) of their research program. The opponents of the mainstream should study the history and sociology of sciences to come up with strong meta-theoretical arguments by appealing to examples in the history of natural sciences. What I see, instead, is: baneful debates about definitions and terminology.
Time’s up for hints wouldnt you say? Every time he ‘hints’ he then comes up with some contradictory ‘hint’ about unsustainability of debt.
As far as I’m concerned he’s doing about as much for the unemployed as he would if he merely changed his definition of full employment to be a U3 of 8.1%.
Excellent piece – thank you.
Those who wish to “starve the beast” but yet wish to end this Depression should no problem with the US Treasury just giving away new reserves to the entire population. Yet the MMT folks never mention this option. Why? Are they more interested in “feeding the beast” than in ending this Depression?
I think MMTers have mentioned this kind of option frequently. But it would require an act of Congress. The Treasury can’t spend a cent that hasn’t been authorized and appropriated by Congress.
Just on a semantic point, reserves are assets of banks, some held in cash, most held in the form of electronic balances at the Fed. Government liabilities issued directly to households in some way would, by definition, not be reserves.
Dan I find a lot of the insights of you and other MMTers interesting. However, I got to say in this post you mostly lost me. I find your concerns here almost “abstract.”
You seem to be saying that if it works it’s almost worse as you see this as promoting “economic shamism?”
I got to be honest, if it works I’m not willing to stand on ceremony. It would be nice to have a Congress that did the things you and I would both like them to do. Guess what? We don’t.
So if this is the only way it can happen right now let’s do it this way. As someone who both doesn’t want a President Romney under any circumstances-his election will literally be then end of the New Deal starting with the end of Medicare and Medicaid-and also quiet frankly has been one of those “undermployed” for too long already if it works I’ll take it. I’m not going to worry about such deeper philosophical quandries
They might be interesting-and perhaps with some validity-in different times but now the idea that we should now stay with the status quo because it makes us virtuouis is for me “a bridge too far.”
I don”t know for a fact that this will work. But I see no harm in trying
By the way, you really underestimate the President. But for him we’d be Britian right now. That’s what a Romney Presidency would be-Cameron the Yankee version.
Mike, in a democracy I don’t think we should encourage forms of government that are based on exploiting ignorance and manipulating the masses. Producing an outcome by mass hypnosis, for example, might yield short-term benefits, but is damaging to the fabric of democratic government.
Government liabilities issued directly to households in some way would, by definition, not be reserves. Dan Kervick
As soon as those Federal checks were deposited in the banks they would become bank reserves at the Fed.
As for an Act of Congress being required that should be not be too difficult. Who is going to oppose receiving free money from Uncle Sam especially since the banks are already getting it (interest on reserves, the carry trade from the Fed discount window to the US Treasury and soon the purchase of MBS dreck by the Fed)?
Also, a bailout of the population would fix everyone from the bottom up. Why isn’t that desirable? Why the distraction of a JG? Afraid of the thieving conservatives are we?
The JG is a way to get that money out there which responds directly to private sector activity.
In numerous posts I have argued that what we need is more spending by the government, directly into the private sector, and that if we want we can do this in a way that doesn’t add to the federal debt or raise taxes. There appears to be zero political traction so far for this kind of proposal. Who would oppose it? The entire Republican caucus in both houses of Congress for one. But I’m going to keep trying.
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Great post Dan. NOBODY in the press – print or TV – could explain exactly what QE3 would do with any degree of precision or clarity. Pundits had talked themselves into groupthink by saying it was a “done deal” before it came out. Either they were tipped beforehand or they became more “certain” as their peers became more “certain.” CNBC slathered all over themselves hyping stocks in the process.
Yep, this is nothing different than the preacher “teaching” his flock that the Bible is the word of god. This is nothing different than a politician promising change, because he himself “looks like” or personifies change itself, even before he’s done anything or engaged in the process. Bernanke reminds me of a Billy Sunday or Elmer Gantry figure in a way, without the evangelical zeal – replaced by a taciturn, professorial vibe. All this is really nothing more than a combination of three behavioral biases “illusion of control,” “overconfidence,” and the “placebo effect.” We essentially talk ourselves into believing something will work, somebody will do SOMETHING because, after all, WE ARE AMERICANS. As Obama likes to say every other day, “THIS IS WHO WE ARE! GOD BLESS THE UNITED STATES OF AMERICA! THANK YOU!”
The shaman always tends to work for somebody. This dancing around the fire trying to awaken expectations is really to distract from the real policy of handing out free money to the wealthiest asset holders, in a sort of emergency plutonomic trickle-down welfare scheme. Whilst the plebs are staring at the shaman’s antics these guys are all in the king’s tent, quietly marking up their accounts.
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As a purporter of what you would call “shaman economics” myself, I think you could be a lot more open to what we say as far as the mechanisms of monetary policy. I’ve read the influential shamans for over a year now and the argument has never been “profits of financial institutions would flow down to common people.” Mainstream economists who have argued vigilantly for bank bailouts have a view much closer to that. Their view is that the Fed could never overcome the failure of big banks. Our view is that the Fed has tools, if it wanted, to increase demand expectations, regardless of the failure of banks or Congress to engage in monetary policy.
The main thing is that QE as well as interest on excess reserves do have a basic mechanism of working. Assuming that people save less when interest rates are less, QE in isolation does have a basic tool through lowering interest rates. At the extreme, the Fed could monetize the entire debt as well as the entire lot of Agency MBS. That would cause mortgage rates to fall to near 1%, as well as all other types of financing. The lower interest rates would furthermore incentivize consumption for those holding dollars. The Fed could also help things along by, say, not paying 0.25% on money that’s not being spent.
Things get more complicated as you assume that market prices are set by rational, profit-maximizing actors. QE2 and now QE3 actually rose interest rates, since the expected future short-term rates increased. If QE actually does increase economic growth and inflation expectations, then future interest rates actually increase. But even with higher interest rates, higher demand expectations give more investments positive NPV, even though cash flows are discounted at a higher rate.
This is what you might call the “shaman” part of Market Monetarism, but this kind of stuff has a lot of basis in how real investors act. It has a lot of parallels with Soros’ “reflexivity,” where the market price itself changes the future cash flows and thus the market price. In the Sumner framework, Fed action and announcements change expectations of future policy and, since market actors take into account these expectations in money management decisions, higher expectations of the Fed willing to do anything to increase NGDP actually makes such action less likely.
It doesn’t always work that way and I personally am somewhere between the Keynesian and Market Monetarist camp. But since the Fed does in fact have nearly infinite power, as I show with monetizing the entire debt and Agency MBS, it does not make sense that they should be timid. It’s just that such actions have been considered so crazy to be outside of possibility, even though they are possible. Meanwhile, it is considered not just possible, but absolutely necessary, by Krugman and others to do trillions of dollars of stimulus. If Congress really did a WWII-esque level of spending, I would agree it would bring us out of the recession, but I find the Fed using the expectations channel, and then using real mechanisms when that fails, to be far more feasible with far less distortion of the economy.
On the matter of expectations, I think I have already stated my view. I just don’t think the Fed has that much influence over the expectations of any significant segment in the real economy. You can tell a nice theoretical narrative about how a central bank could conceivably have such an influence. But I am not convinced that those stories are even near representations of empirical reality. You can tell all sorts of nice theoretical narratives about how expectations of price changes feed back into the setting of actual prices. But for those narratives to get off the ground and give you a viable Fed policy, you have to assume that Fed statements coupled with actions like QE3 actually impact price level expectations in some significant way. We shall see whether that is true.
There is also a nice textbook story about how rising inflation expectations lead people to spend more. But I don’t buy that one either. I recently posted an article that presented some empirical evidence that many actually people respond to higher inflation by saving more, as they sense that they need to save more to extend their present level of purchasing power into the future when prices will be higher. My hypothesis would be that when an agent’s inflation expectations are not coupled with expectations of receiving equivalently higher nominal wages, then you don’t get the spending increase.
I work in a company with 300-400 people onsite, with different levels of authority and responsibility, and I have never heard a single one of them even mention the word “Fed” in the course of business or leisure. Now no doubt there are lots of people on Wall Street and in the financial sector who chatter incessantly about the Fed – and their expectations, from what I can tell, swing all over the map. Anyway, that’s what I meant by saying monetary policy enthusiasts are fans of trickle down thinking. They think everything emanates from the financial sector, and flows down from there, and so that the only expectations that need to be changed are those on the street. But I believe that picture is upside down, and that the economy grows from the bottom up, with the financial sector following along to accommodate exogenously generated demand from outside the financial sector.
Buying up all of the crappy MBS on bank balance sheets might have an impact if lending is being held back on the financial supply side. But I have trouble believing that is the case since banks are swimming in excess reserves.
The Fed has no effective way of injecting demand into the real economy. I have read Sumner and others asserting otherwise countless times, but I simply don’t believe them, and they have never given a convincing story about how that happens – a story that does not depend on expectations magic.
I suspect that the “golden age” of Fed expectations-setting, such as it was, is rapidly coming to a close. To the extent that the Fed had the ability to determine significant shifts in economic expectations, that ability was based on widespread public ignorance of the operational realities determining Fed operations in the contemporary period, and on crude textbook models of the central bank as all-encompassing “monetary authority. The more people look, the more they realize how little “there” is there – at least at the zero bound. With growing public knowledge of the operational details, the ability of the Fed to move expectations shrinks.
Monetizing the debt sounds interesting. Exactly what kind of process are you envisioning? Most of the processes I can think of would require additional Congressional authorization.
I specifically that almost nobody, including executives of small and medium sized companies, would think about the Fed or its actions at all. Your executives may not talk about the Fed at all, but they definitely talk about their sales pipelines and future, uh, expectations of sales. Their sales expectations are in turn set by customers, and their spending habits are set by THEIR sales expectations.
This theory was around long before Sumner. It is the basic theory of the paradox of thrift and Keynesian unemployment. It is the story Krugman published in 1998 about the baby-sitting co-op. It has been the mainstream theory of cyclical unemployment in saltwater economics for years. (I personally think freshwater economics truly are shamanistic, but due to their utter lack of evidence, not their theories per se).
This theory, any way you look at it, is pretty “shamanistic” in and of itself. The theory does not care about how or why customers reduce spending and increase saving. It could be because they think Obama will take their guns, or believe in Austrian Business Cycle Theory, or watch CNBC. Keynesian theory of the paradox of thrift is agnostic to the reason demand decreases.
The crux of the issue is then two things:
1. Which possible government actions could increase demand?
2. Which of the possible government actions involves the least cost?
It’s important to mention that together, Keynesians and Market Monetarists are 90% there. No, the unemployment is not structural. No, unemployment is not some divine punishment like people Medieval in times thought the black plague was divine punishment. No, people didn’t suddenly become lazy or stupid or “Zero Marginal Product” workers. The problem of unemployment is almost entirely a problem of demand. And demand itself is set in shamanistic fashion, of every person guessing what the other person is doing and the other person guessing guessing what that person is doing. In game theory terms, they can settle on an equilibrium which will be less beneficial than another equilibrium, i.e. full employment.
Market Monetarists merely take the shamanistic paradigm to its full extent, to where expectations of future spending are the ultimate lever of any policy, fiscal or monetary. Whether monetary policy can increase expectations is the issue, and to sustainably increase demand expectations, it needs mechanisms to increase demand without expectations. Furthermore, if monetary policy CAN increase demand, it is far less costly than using fiscal policy. The fiscal policy of WWII, for example, did bring us out of the Depression, but there was a severe reduction in living standards during WWII. Monetary policy increases private demand, through mechanisms such as interest rates, which generally increase living standards more than public spending. This is especially the case today, since true infrastructure spending takes a long time to get moving and American infrastructure is more expensive than other countries.
That then raises the question whether the Fed can raise expectations if nobody in the market believes anything differently about future demand. It is clear they can outside of the zero bound. Borrowers like to spend less money when they borrow. More investments make financial sense at lower interest rates. Even outside the zero bound, it’s worth point to how monetary policy created a sharp recovery in the mid-80’s with unemployment at similar levels. But what about the zero bound? Well, there is the pesky issue that we are not really at the zero bound. The Fed Funds rate should actually have a floor of 0.25% because the Fed is paying 0.25% on excess reserves. 10 year rates are still more than 1% and the Fed could, in theory, have no issues pushing those down to zero if it wanted to (it already has Congressional authority to buy Treasuries on the open market in unlimited quantities). Even if it didn’t push it down to zero, the 10-year bonds the Fed buys exchange a 1.5% asset with a 0.25% interest asset. Some market participants may in fact start to think the current yield of the stock market at 6% sounds good compared to 0.25%. If the yields on other assets are pushed down, then more investments make sense.
As far as other non-expectations mechanisms, I actually agree “buying crappy MBS” would help banks lend more. Besides the free 0.25% interest, banks are sitting on so much excess reserves because of lack of positive NPV investment opportunities. But why are there not opportunities? Because there is low demand expectations. Unfortunately Bernanke disagrees with both you and me on this and has thought bank “liquidity” and “health” is extremely important to an economic recovery. In fairness, the MBS he has bought and will buy is already backed by the government and they’re not really “crappy MBS.” Still, whether or not the QE goes to MBS is irrelevant in my opinion. The main thing is new money is exchanged for assets currently getting decent interest, and there’s still trillions and trillions of those kind of government-backed assets left.
Then there’s expectations. For the market to remain completely idle while the Fed engaged in assets and announces concrete goals means that the market is irrational. Pure rational, profit-maximizing agents continuously adjust market prices to their current perceptions of future demand. Under the Efficient Market Hypothesis, price changes signal news and unexpected events. In the real world, you are correct that agents have a distribution of opinions on future demand, but based on the mechanisms above, the average expectations of demand should at least shift somewhat. And if demand expectations did in fact shift on a Fed announcement, then you would find the following in asset prices in a rational market:
1. Long-term Treasury yields would go up, not down. This is because more demand growth means we are more likely to exit the zero-bound sooner.
2. Inflation expectations (i.e.) TIPS spreads go up. To respond to your comment that inflation expectations increase savings, that doesn’t make much sense. Inflation can only happen if demand increases. Just like business managers do not hire based on Fed announcements, they don’t raise prices either. They only raise prices if they have pricing power, i.e. if their market does not have slack and their demand increases. Inflation expectations cannot itself lower demand, because inflation only increases when demand increases. The exception is supply-side inflation, but Fed action does not increase supply-side inflation.
3. Stock prices and other risky asset prices would go up. Even keeping their discount rate constant, their asset prices should go up with higher future demand because generally businesses have significant fixed costs and they have the highest profit running at full capacity. Therefore higher future demand would mean both higher employment (to run closer to full capacity) and higher profits.
And these three things are exactly what we have seen, as Sumner has long predicted. They are all based on the simple assumption that markets actually do care about fundamental valuation and it is clear monetary policy decreases fundamental valuation for Treasuries, increases TIPS spreads and increases future profits. You seem to have an extremely pessimistic view of the markets similar to Keynes, who thought stock markets added no social value and that it was just a “beauty contest” where participants acted purely on what they thought other participants were thinking.
But the economy’s cyclical nature is a beauty contest. Nobody goes into business if they do not expect demand, and demand does not happen if nobody goes into business. At extreme irrationality and VERY extreme propensity to save among debtors, the Fed would swap 0% yielding cash for 1+% yielding Treasuries. A whole lot of people out there, roughly 11 trillion in savings, would have to be fine and happy earning 0% for the action not to increase demand significantly. A further 7 trillion is MBS already guaranteed by the government but earning 1+% yield. People holding $18 trillion of savings would need to be happy with 0% while, say, stocks are earning 6%. GE recently had a preferred issue which was a 7% yield. And even at that extreme, the Fed could charge interest of reserves (instead of the current positive 0.25%). How much pain and missed opportunities for wealth would holders of this cash endure until they start spending some of that money? Because of all of this, I see unlimited ability for the Fed to increase demand if these steps were politically allowable.
We need the NEED Act, United States Notes (usury-free), and Public Banking (banking as a public utility). The Monetary Authority should be an open-source algorithm that by law must balance money supply to real economic productivity, not finance capitalism. The National Debt of the US should be paid off with the new money: United States Notes. Governmental debt at every level should be illegal. It is completely unnecessary and counter-productive. Full employment (public and/or private; public if private can’t or won’t) should be realized, per the NEED Act (enhanced).
Now, can you instruct the people to elect only those who will fix the economy rather than continue the Ponzi scheme?
Ben Bernanke is stuck within a range of movement that doesn’t include any of the above. Within his box, he’s actually doing a good job — better than I expected.
QE3 is not going to be as QE1 and QE2. Focusing on real estate, not messing around with Treasuries, and having it be open ended was smart, given his options.
I’m sympathetic to all of those suggestions.
People on Wall Street benefit the most from QE. As always, policy is directed primarily towards satisfying their desires. “Portfolio rebalancing” and “wealth effect” as the means of curing a depression = make the rich richer in the hope that some money might trickle down. Lower interest rates as a means of curing a depression = get the plebs even more in debt to Wall Street. Then we can raise rates and crash the whole thing again, Wall Street can foreclose and steal even more real assets from the population.
You are right. The threat to democracy is very real.
The solution to this problem is a decentralized monetary system coupled with good education for the general public based on information transparency.
There are many ways to achieve decentralized monetary systems. One of them is to use Bitcoin, another way is to use Ripple Networks.
All this reminds me of the shaman whose role it was to name all the children in the village at birth. One day, one of the children came up and asked the shaman how he got all these great names for all the children. The shaman replied – I just look out to nature and whatever I see, that becomes the childs name … like “running river”…” red sky”….but why do you ask “2 dogs f…..g?
It feels like Bernanke wants us to remain in the last seat of the roller coaster when the leading carriage is rolling over… it sure feels like its still going up but no matter how much money is thrown at you to convince you the ride is still heading upward, no one can suspend the belief in the pit of your stomach that its all about to come crashing down. We need a new exit point on the roller coaster.
best article I have read on the QE topic – thanks.
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