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Wednesday, December 8, 2010

Thoughts on QE II

The stated goal of QE II is to raise inflation expectations. ('cuz wishing will make it so.)

Markets respond to higher inflation by raising interest rates. But these are nominal rates. The real interest rate is the nominal rate minus the rate of inflation.

The apparent paradox is that higher nominal rates are (within reason), in fact lower real rates. At, or ,the zero-bound, real rates are HIGHER than nominal rates. In actual deflation, they are much higher. I've seen the real rate during the Great Depression estimated at north of 11%, when long T-bond nominal rates were negative.

The idea behind QE II is that increasing the monetary base will lead to increased expectations and inflation.   Menzie Chinn examines the real world historical effect of this approach, and finds it wanting.

In comments there, Barkley Rosser points out "that monetary base is not the same thing as money. So, indeed, it can be formulated as a problem of the multiplier, that in this recessionary state, the multiplier has collapsed, arguably a variant of the old "pushing on a string" argument."

 Oh, yeah.  The multiplier.  It died two years ago.

Here's how I connect the dots:  It's GD II, things are going to get far, far worse.  Employment will not recover unless and until something drastic happens.  God only knows what that may be; perhaps a 2nd amendment solution.  But who has the guns?  I am eskeered!
.

3 comments:

nanute said...

Thanks for the explanation. So, what you are in effect telling me is that when the Fed says they are trying to lower long term rates, they are alluding to the real rate? (more inflation = lower real rates.) Under current conditions, this is indeed wishful thinking. No demand for goods and services = no inflationary pressure on real rates. Correct? Pushing on a string? To quote an old football coach: "it looks like a frog pissing up a rope."

Your outlook on the future, is I fear, spot on. The Republicans are hell bent on reducing the deficit, except when it comes to tax cuts for millionaires, which means they'll be looking to drastically reduce spending in the upcoming budget.

Jazzbumpa said...

I don't recall haring anything about reducing long rates, so I can't help with that specific question - but I do not see all nor know all.

It's a failure of aggregate demand. People without jobs can't spend. This is the fallacy of off-shoring jobs. No demand - no hiring - no jobs - no demand; wash, rinse, repeat. Meanwhile, the personal part of the private sector is - perforce - deleveraging, which means even less demand.

This is the recipe for a deflationary spiral.

The answer is fiscal stimulus, and that is not going to happen.

QE II increased long rates all the way back up to where they were 6 months ago.

http://krugman.blogs.nytimes.com/2010/12/08/bond-vigilantes-still-invisible/

The Rethugs don't give a rat's ass
about the deficit, jobs, the people nor any aspect of the economy. In fact, they have no principles of any kind. Other than the last few years, I don't know if that has ever been true before.

And the Dems are feckless.

God, what I wouldn't give for some feck!

Hence, my despair
JzB

nanute said...

We are in complete agreement on the need for fiscal stimulus. And with the tax cuts are the solution for all that ails the economy crowd getting ready to take over, federal stimulus/job creation is a non-starter. The solution to be sure, but not gonna happen.

On QEII: If inflation is the intent, then by default the lowering of real long term rates would follow. No? Otherwise, deflation would make real long term rates higher. Or, am I totally confused? I'm gonna have a drink now.