The Federal Reserve is back at it. After increasing the monetary base — currency in circulation and bank reserves — by about $1.2 trillion over the last two years, the Fed has decided to expand it again, by another $600 billion. This second round of “quantitative easing” or QE2 has many conservatives worried. They are concerned that these staggering increases in the monetary base have the potential to unleash a 1970s-type inflation and put the country on the path to economic ruin.
Because of this unease, QE2 has been widely criticized by conservative commentators — including Sarah Palin, Rush Limbaugh, and Glenn Beck — and has led Republican representative Mike Pence (Ind.) and Republican senator Bob Corker (Tenn.) to introduce legislation that would change the mandate of the Federal Reserve.
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But in fact, if it works according to plan, QE2 will promote conservative principles.
One reason for this confusion is a failure by some conservative commentators to understand the real purpose of QE2. It is not solely about lowering interest rates, increasing bank reserves, and encouraging bank lending, though all of those will occur. Rather, it is about fixing a spike in the demand for money that has significantly hampered spending.
To better understand this excess-money-demand problem, consider the figure below, which is based on data from the Federal Reserve and the Survey of Professional Forecasters. It shows total current-dollar spending in the U.S. economy, as measured by nominal GDP, for the period 1993:Q1 through 2010:Q3; the consensus forecast for the series up through 2011:Q4; and the 1993–2007 trend. Note the 2008 drop in total current-dollar spending relative to its former trend. The gap between the trend and reality is projected to get larger through 2011. In fact, by 2011:Q4, total current-dollar spending will be about $2.14 trillion below its trend.
Why the drop in 2008, followed by a sustained slump? The easy answer is that the housing bubble popped and caused a financial crisis. The resulting uncertainty from this crisis curtailed aggregate spending, which continues to stay depressed because of the ongoing deleveraging cycle.
While there is some truth to this view, it is incomplete and ignores some basic issues. First, total current-dollar spending is the product of the money supply and how often it is spent. Because the monetary base has been increasing so rapidly and there has been very little inflation, it must be the case that demand for the money must be increasing even more. In fact, money demand has been so pronounced that even the previous $1.2 trillion increase in the monetary base was not enough to prevent outright deflation in 2009 or a sustained decline in core inflation (which shows the trend path of inflation) over the past two years. Thus, a significant portion of the money supply is being hoarded and not spent. This is the excess-money-demand problem.
Please demonstrate to me what part of government control of free markets in any way demonstrates 'conservative principles.' Also please demonstrate to me why allowing the Fed to continue to play with money supply issues that directly contributed to the mess we're in now makes any sense. I have officially lost interest in NRO's opinion, thanks so much.
Mr. Beckworth hasn't convinced me. Inflation is already here -has been since early 2009. By definition, anytime you increase the supply of money you introduce inflation. Price inflation, will surely follow. Besides, the CPI does not take into account the price of food or energy (both are commodities). The CPI tilts towards housing costs; we are still in an era of falling real estate prices. And most banks have substanital holdings in mortgages. With falling home prices, as well as the foreclosure mess, banks have a big cash flow problem. Add also the higher FDIC premiums banks must pay, and it is no wonder banks are "hoarding" thier dollars. And as thier mortgage assets depreciate banks must make up for the loses somewhere.
This is the quandry Bernecke finds himself. He must devalue the dollar in order to pry the "hoarded" cash from the fingers of reluctant banks and corporatons. Individual savers will be reluctant to invest in CDs or higher yeild money market accounts if dollar significantly depreciates. Bernecke hopes to artificially create demand at a time when consumers are very reluctant (and unable) to go on another consumption bender.
But, behind the scenes real estate and home prices continue to fall. This is the real problem that TARP failed to solve. Who knows where the bottom lies. The federal government surely doesn't know.
One last unintended consequence to all of this stimulus is speculation. Negative interest rates and a falling dollar may not lead to higher corporate and consumer spending. But it could lead to a new market bubble.
Mr. Beckworth presents no credible justification for printing more money. What in the world is "money demand?" Money is a means of exchange, not a good or service that is produced and sold. I feel sorry for the poor students of professor Beckworth who are being required to study ideas that make no sense.
This is a very dispiriting article to find on NRO.
First, there's the pathetic appeal to "conservatism": we have to indulge in foolish, interventionist economic policy because otherwise the public will demand even more foolish, more interventionist economic policy. This is the same argument that Fabian socialists always use. We have to have a welfare state to forstall a proletarian revolution; we have to pass a Medicare drug benefit to avert full-blown socialized medicine. Nonsense. Nothing in the current public mood suggests that people are clamoring for stimulus and intervention. Quite the contrary: "stimulus" is now a dirty word.
Even worse, though, is Mr. Beckworth's substantive argument. It's basically the same stale, Keynesian, magical thinking that we hear from the Left: People are irrationally "hoarding" their money, so we need to manipulate them into doing the rational thing by threatening them with inflation. We can somehow magically create value if we churn money around and pay each other for ephemeral goods we don't need. We can simultaneously de-lever and increase spending.
This is positively pernicious. Money will emerge, and be invested, when to do so is rational. Wealth is not created by consumer spending. NRO should be doing everything it can to drill home these points and break the hold that Keynesian arguments have on the public mind, not running apologists like Mr. Beckwith.
Mr. Beckworth, the real conservative solution to our current fiscal/political problem is sound money reform. Advocating for the Fed to further destroy the dollar so that the big banks can reap more profit even as they've made a moonscape of our economy is fool-hardy. Central banks around the world are the tap roots of big government socialism. Ending the US central bank would cut off the tap root and whither big government socialism. I don't see that solution offered much except on the gold bugs sites. I am a staunch social and fiscal conservative and to me it sounds like you're shilling for the big banks. I don't want to think that way, but apologizing for the Fed to take a bigger share of our incomes through currency inflation so that the Federal government can get stronger?!? Which side are you on?
I wish Ron Paul was a social conservative so that his sound money message would get through, but as a Libertarian candidate everyone puts a tin-foil hat on him and snickers below their breath. He is right! As was Thomas Jefferson regarding the role of central banks in growth and power of government.
Throw the spotlight on the corruption that comes from the incestuous relationship the big banks have through the Fed and how they bank-roll Congressmen - (mostly) Democrats and (but) Republicans (alike) to redistribute our wealth to the bankers and I'll give you some credibility, but until then you're on my "squishy" list.
The article if wrong. The first basis for the NEED for QE2 states:
"Because the monetary base has been increasing so rapidly and there has been very little inflation, it must be the case that demand for the money must be increasing even more."
This is NOT correct. If there were a true demand for money, INTEREST rates would go up. Interest rates are the PRICE of money ... how much are buyers ( people demanding money ) willing to pay up for availability of such funds today. And the answer is NOT MUCH ... we have very low 5 and 10 year rates because there is low demand for money.
The reason there is little inflation is also because .... there is little demand.
The entire article can be tossed out and a smoke and mirrors argument ... just don't look behind the curtain.
The article flatly wrong. The 'need' for QE2 is based first on this erroneous assessment:
"Because the monetary base has been increasing so rapidly and there has been very little inflation, it must be the case that demand for the money must be increasing even more."
Not correct. If there were demand for money, then INTEREST rates ( 5 / 10 year rates ) would go up. That is, demand for money today would drive individuals to pay up ( higher rates ) in order to secure such money today. This is NOT happening. The opposite, in fact, is the case. Demand for money is LOW, so low in fact that inflation has NOT materialized even with the huge supply of cash being 'borrowed' from future generations.
This article is simply a smoke and mirrors exercise. NRO should know better.
Thank you, Allen. Great comment. There aren't any magical "animal spirits" that Bernanke can awaken to save a fundamentally flawed monetary/economic/political system. Ultimately, the Fed is just trying inflate another bubble, but debt deflation is still occurring. The Fed's efforts will likely accomplish nothing more than prolonging and exacerbating the pain. Better to take our lumps and move forward with real savings fueling investment, but the Fed only knows how to use a hammer, so everything looks like a nail to Bernanke.
Hey, Kevin Williamson, you want to chime in here or are you going to let this article go unchallenged?
Actually, Mr. Beckworth is correct, but for the wrong reasons. Demand for money is increasing due to deleveraging. His argument is flawed relating to QE2. There is 4-500 trillion world wide that needs to be deleveraged, and will be over time, sooner rather than later. The FED QE2 of 600 billion is like using a garden hose to put out a raging fire of a 10,000 square foot house. In the end the FED will either voluntarily give up trying, or will simply be overwhelmed by the fire. Sorry, folks, what is at play here is natures law, and there is nothing anyone can do about what is about to happen.
Beckworth has done a great job in explaining the reason for quantitative easing. However, rather than proposing a 2 percent growth path for the price level, a 3 percent growth path for money expenditures on goods and services would be better, with the new target path starting at the beginning of the recession in 2007. Not only would this correct the immediate shortage of money and allow the sort of prompt recovery that occured when Reagan was President, it would put the U.S. in a position to resume sound growth without inflation.
Beckworth is an opponent of monetary central planning. His column merely gives pragmatic policy advice given the Fed exists and will not be abolished any time soon-- it is not an endorsement of central banking. Beckworth is merely arguing that more quantitative easing by the Fed is better than less in the present circumstances, for a variety of reasons specified in the column.
Allesnarf argues against QE2 because it is “foolish, interventionist economic policy”. But what Allesnarf doesn’t seem to realize is that not engaging in QE2 is also “foolish, interventionist economic policy”. The mere fact of having a central bank (the Federal Reserve) means having interventionist economic policy. Given that we have a central bank, what Allesnarf needs to argue is why his foolish interventionist economic policy of low aggregate demand without QE2 is superior to higher aggregate demand with QE2. During a period with under-utilized resources and high unemployment, it seems to me that an increase in aggregate demand brought about though QE2 is warranted. What the Federal Reserve is doing with QE2 is not much different than what it has normally done since it began open market operates in the 1920s. The Federal Reserve expands and contracts the money supply by buying and selling short-term treasury bills. But because of very low short-term rates it must purchase long-term treasuries instead to get spending to increase.
Satisfying an excess demand for money by increasing the money supply 1) is not pernicious and 2) is not inflationary. What is pernicious is not satisfying people excess demand for money by increasing the money supply, because an excess demand for money creates an excess supply of goods and services, i.e. under-utilized resources and high unemployment. If you think increasing output and putting people back to work is a good thing then you should support QE2. On the other hand, if you are satisfied with the current level of output and unemployment then go ahead and oppose QE2. However, this leads to Beckworth’s other point that the sagging economy leads to more fiscal intervention by the federal government and bigger budget deficits. Second, people define inflation in many ways. Some believe increasing the money supply by one dollar is inflationary by definition. These people will not be swayed by any argument, but if the money supply is constant and there is a sudden decrease in the demand for money, this would be inflationary and the proper response should be to reduce the money supply to meet the reduction in demand for money, otherwise prices will rise. Currently, we have the opposite situation: there is an excess demand for money that must be met by increase the money supply.
For those who see inflation in every cherry picked commodity they choose should realize that the CPI is very low, running around 1.2 percent. Compare this to 4.5 percent inflation by the end of Reagan’s term and you can see that Bernanke has hardly been an inflationist. And the 1.2% inflation is an average, there are always some prices running above the average and some that are below the average. Cherry picking only those commodities that are above the average to argue that there is inflation is like arguing that every child has above average intelligence.
"But in fact, if it works according to plan, QE2 will promote conservative principles."
And that little sentence caused me to stop reading the entire thing. Nothing ever works "according to plan" and usually when central planners do something that actually works, they are quite surprised by the fact that whatever they proposed actually worked. It is hard for me to take an argument seriously that requires me to place faith in the machinations of men and is not based on any real test.
If Mr. Beckworth is serious about this being a "conservative" issue, he would also write an article about what would happen if QE2 fails.
As so many of the comments have pointed out, Mr. Beckworth, your assumptions are flawed. The whole "monetarist" economic school of thought is nothing more than a shell game. It has as much validity as the prosperity of socialism.
One cannot control the economy via monetary policy or any other governmental policy. One can only squish and squeeze the water balloon into different shapes causing dangerous bubbles to erupt.
The current monetary policy is doing nothing more than attempting to fuel yet another bubble. The Fed must learn that the market should drive interest rates not the Fed.
Constant "growth", as the Fed calls it, is NOT good. It only enables the government to more easily borrow and spend. It's a flawed policy that leads to corruption, lack of accountability, and sever economic conditions. The Fed causes these economic cycles that are erroneously called "business cycles". Even laymen can see and understand this concept: why can't the Fed?
The goal of quantitative easing is not to pry cash from the hands of reluctant banks, firms, and households. In fact, the objective is precisely the opposite -- to provide enough money so that banks, firms, and households can satisfy their demand for cash balances.
The money supply is equal to aggregate cash balances, i.e. all money is held somewhere and by someone at all times. All else being equal, if the total quantity of money people wish to hold increases, then people will begin trying to hold more money than exists! Unless the money supply increases in proportion, it will be impossible for everyone to satisfy their desired money balances. This is what is meant by an excess demand for money, and while the Fed operates its monetary monopoly, it is the only organisation that can restore equilibrium in the supply and demand for money.
Beckworth claims that money demand (i.e. total desired cash balances) will begin falling if the Fed succeeds in its task. Banks, firms and households that are reluctant to spend right now will become more confident and begin taking advantage of emerging opportunities, i.e. there will be no prying from reluctant hands!
The concept of money demand is inexorable from monetary economics; it more or less identical to the concept of money velocity. So-called "conservative" economists like Hayek, Friedman, and Mises all made use of the money demand concept, though often referred to it with different terms.
Beckworth is not arguing for monetary central planning, but instead reluctantly accepting its existence and answering the next question: what is the least bad monetary policy for a central bank? He concludes that QEII more closely approximates his "least bad" policy than no QEII, but also notes that without an explicit rule-based target (preferably for some measure of nominal income), QEII is not enough.
Furthermore, "hoarding" (i.e. an increase in money demand) is not irrational. Beckworth explains, without appeals to Keynesian animal spirits, that, "Instead, creditors are sitting on their money because they see an uncertain economic future. Creditor households are reluctant to buy new cars or get their kitchens remodeled lest they lose their jobs in the future. Creditor firms, meanwhile, are reluctant to build new plants since they cannot see how they would be able to sell all the new production coming from those plants. Similarly, creditor banks are not increasing lending as there is little demand for funds and few creditworthy borrowers." There is nothing irrational about demanding higher cash balances, but unless that increase in demand is satisfied with an increase in supply, deflation (or disinflation), high unemployment, and recession are the likely consequence.
Money is one half of every transaction, so when there is a disequilibrium in the supply and demand for money, everything else is also thrown into disequilibrium. When there is an excess supply of money this results in housing bubbles and inflation, and when there is an excess demand for money it results in recessions, deflation, and more government intervention.
Beckworth explicitly states that he expects any weakening of the U.S. dollar due to QEII to be later reversed by growing output. As money demand is satiated, nominal incomes will rise and unemployment will fall. As sales begin picking up firms will begin investing once again (while avoiding the failed projects of the housing boom). In other words, QEII can help spur an economic recovery that will eventually strengthen the U.S. dollar.
You may disagree with Beckworth about the likely consequences of QEII, but it is disingenuous to claim that he advocates the Fed "further destroy the dollar" for the benefit of big banks.
Lee,
I respectively disagree with you. The Fed Chairman, in his public remarks, appears to be more interested in achieving better employment stats than the more escoteric issue of the M3 or M2 money supply (something which the Fed doesn't track anymore).
In any event, banks balances are largely affected by real estate prices. Most banks have extensive mortgage holding, and the values of those properties are obviously a big concern. Large cash holdings by banks are just one way to offset foreclosures and falling property values (BTW, October was another grim month for real estate). Another way is to borrow cash directly from the Fed, and use the cash to buy T-Bills. The spread between what the Fed charges them (0% or better), and the T-Bill yield (2-4%) is pretty good. However, QE2 goes against both efforts. QE2 weakens the dollar, and thus is a disincentive for banks to either hold cash or buy T-Bills.
But offering up more liquidity to banks, the Fed is just chasing its tail. Banks will continue to have cash flow problems as long as real estate prices continues to fall. The Fed is treating the symptom and not the root cause. I do feel for Mr Bernecke; much of what ails this nation economically are problems that can only be solved by our political institutions, and not our financial ones. As weird as it sounds, both hyperinflation and deflation are still possible.
You are confusing money and credit. The demand for money is a kind of saving, while the demand for credit is a kind of dissaving. An excess demand for money usually correlates with low interest rates, because it reduces nominal incomes, increases the real burden of debt, and reduces the demand for credit. The purpose of holding money is practically the opposite of going into debt.
Interest rates are not "the price of money", but rather they are the price of borrowing. The "price" of money is just the inverse of the price of anything else. For example, if one hamburger costs $5, then one hamburger is the "price" of purchasing $5.
