Winner of the New Statesman SPERI Prize in Political Economy 2016

Tuesday, 20 January 2015

When central bank losses matter

This is a post about why the taboo against helicopter money or money financed fiscal stimulus is irrational once we have Quantitative Easing, but might nevertheless be in the interest of some groups.

Many macroeconomists have argued that we shouldn’t think about central banks in the same way as private banks. A central bank can never be insolvent, at least as long as people use the currency it issues. It can cover losses by creating more money. All that matters, from a macroeconomic point of view, is whether it has the ability to do its job, which is to control inflation. 

I do not want to talk about controlling inflation here. Instead I want to talk about these losses, and in particular who gains when these losses are made. Macroeconomists tend to focus on the controlling inflation point, so let me avoid that by imagining a really simple world. There is a constant price level target, and base money velocity (nominal GDP/money) is constant in the long run, so base money must return to some constant value in the long run to meet the target. In the short run velocity is not constant and we can have recessions due to demand deficiency in the usual way.

Think about Quantitative Easing (QE). [4] The central bank creates money to buy government debt in the market at a time when that debt is expensive, because it only does QE when interest rates are low. [1] Suppose it just so happened that all this government debt that the central bank buys comes from pension funds. These funds sell their debt, take the money and keep it as money. After some time, the economy recovers, interest rates rise and the price of this government debt falls. The central bank no longer needs the debt, and it wants to reduce the money stock to get to the price level target, so it sells the debt back to the market, or more specifically to the same pension funds it bought it from. As the price of these assets has fallen, the central bank makes a loss. The pension funds gets back the debt they originally sold, but they have some money left. They have gained.

Good for them you might say - why should I care? Well the central bank is concerned that it has not got all its money back (it made a loss), and to control inflation it needs to take more money out of the system. It asks the government to recapitalise it, which the government does by raising taxes. What has in effect happened is that money has passed from the taxpayer to the pension fund.

My purpose in pointing this out is not to make some distributional point. Instead it is to note that QE in this case involves the central bank giving money away to pension funds. So why is this considered kosher, but the central bank giving the same amount of money (its loss on QE) directly to the public is considered deeply problematic? [2] Why would it be thought completely wrong for the central bank to voluntarily give the same amount of money to the government so that they could help stimulate the economy by some fiscal means (a money financed fiscal stimulus)? [3]

If you think that my assumption about price level targets and constant long run velocity was somehow critical here, imagine the case where to meet its inflation target the money newly created in the long run (the loss on QE) did not need to be taken out of the system. The pension funds gain but no one seems to lose. But if the expansion of money had been via a helicopter, then every citizen would gain instead. So why is acceptable to create new money and give it to pension funds (through losses on QE), but not create money to give to ordinary people or the government? The former is called monetary policy and is OK for a central bank to do, but the latter is called fiscal policy and this the central bank cannot do.

Why does this matter, apart from the distributional point? Because as a means of stimulating the economy in the short run the effectiveness of QE is highly uncertain compared to the effectiveness of direct transfers to citizens or public works. We seem to be stuck with an ineffective form of stimulus, because something more effective is taboo, or goes by a different name. To repeat it in a simple but more provocative way: a central bank giving money to people or governments is out of the question, but a central bank giving money to parts of the financial sector is just fine. That is a very convenient taboo for some.  


[1] Suppose this is government debt issued many years ago, when interest rates were 5%. So debt with a nominal value of £100 pays 5% interest. If interest rates are now 2.5%, then this debt is more valuable than its nominal value - indeed someone would pay you something near £200 for it if it had a long maturity. However if interest rates go back to 5%, the value of the debt would fall back to £100.

[2] Assume Ricardian Equivalence does not hold, so giving money away now is expansionary even though that money has to eventually come back when the central bank is recapitalised.

[3] If the money financed fiscal stimulus was in the form of additional but temporary government spending, and when the central bank was recapitalised the Treasury paid for this by temporarily reducing government spending, we get what I call a ‘pure’ money financed spending stimulus. I know of no theory which says that would not be expansionary. 

[4] If you want to be topical, you could think about creating money to buy foreign currency instead.

95 comments:

  1. It's always puzzled me both as to where economists think the dividing line between monetary policy and fiscal policy is, and in the case of central bankers where they derive the democratic legitimacy for crossing the line between monetary policy and fiscal policy. When central banks pick asset classes to buy via QE are they not picking winners and losers? It's always struck me as slightly ironic that "Market" monetarist are are in favour of this type of intervention but more so.

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    1. Human nature and the nature of politicians seeking votes makes "temporary" fiscal stimulus turn into permanent vote buying. Remember how inflationary govt was before independence was granted to the Fed. The political wing is not responsible enough to manage it.

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    2. we had a stimulus in the US, and it did not turn into anything permanent.

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    3. You also had a surplus in the US and it got spent on tax breaks for the rich, and a war in Iraq. While you have a political cycle that is shorter than the Economic cycle, you will always end up with failed policies. Unless there is an equal coalition with no single dominant party as we have today. The only way to get that is to elect via full PR, but Cameron neatly scuppered that by only allowing the worst possible and least popular type of PR to be considered. Fait accompli.

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  2. This example highlights a simple point that rarely gets made: unless the central bank exits QE at exactly par, there is a transfer of value between the private sector and the public sector - or, if taxation is used to recapitalise the central bank, between tax-payers and the private financial sector. In other words, quantitative easing removes any clear distinction between monetary and fiscal policy. Public ownership of private bank equity, such as RBS, leads to similar transfers at the point when banks are re-sold to the private sector.

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    1. That is a very clear way of putting it. I would only add that exiting QE at par is very unlikely for the reasons I give, and I think central banks understand that.

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    2. Agreed. There are two alternatives to recapitalisation by taxpayers: one is Adair Turner's recent proposal to declare some QE 'permanent' (and simultaneously write down government debt); the other is to finance recapitalisation by issuing bonds. Regardless which is chosen, the line separating fiscal and monetary policy is pretty much eliminated.

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    3. Every now and then shibboleths arise that acquire the status of holy writ. One of these is the necessity for central banks to be independent of political control. A bogus distinction between fiscal and monetary policy needs to be created to justify this confiscation of authority from accountable policy makers to unaccountable bureaucrats. Initially this justification was on the grounds of efficiency: experts free of political pressure make better policy decisions than here today gone tomorrow politicians.

      Of course once political control was removed central banks were easily captured by their own small but powerful constituency - the finance sector. The Swiss central bank provides a timely lesson.

      1.) There is no "effeciency" premium in central bank independence. The Swiss bank has just done something far more radically stupid than elected Swiss politicians would ever have done.

      2.) The Swiss central bank is a privately owned (for profit) institution and so it was fully absorbed by the private financial sector and was therefore panicked by the expansion of its own balance sheet.

      In an open democratic society Governance is only as efficient as the accountabilities that operate. An independent policy making body is never as efficient as one subject to direct political accountability......

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    4. The other ZLB that needs elimination is that of bank balance sheets.

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  3. "The former is called monetary policy and is OK for a central bank to do, but the latter is called fiscal policy and this the central bank cannot do."

    I would term heli's where the treasury and the central bank cooperate hybrid monetary/fiscal policy not fiscal policy. The central bank could conduct heli's of emoney it issued independently of the treasury and these would be monetary actions as no borrowing is involved, only printing and placing in people's accounts.

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    1. A money financed temporary increase in government spending involves no borrowing. I think the problem is partly that we want to call something either 'monetary' or 'fiscal'. We should start by thinking about a combined/consolidated government and central bank, and then ask whether the institutional division we create does the job it is designed to do. The current division does not.

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    2. I don't think the problem is a separate central bank. The problem is that the central bank interacts with the wrong counter-parties (banks and financial entities) instead of the broad public. Also the central bank needs to be more accountable to the public.

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    3. CMA, what you are talking about is just fiscal policy (i.e. government spending or 'transfers' ) carried out by the central bank instead of the treasury.

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  4. A little recap of my 2012 complaint to the BBC and BBC Trust:

    Matthew Degnan, BBC Complaints, 02 May 2012:

    "In terms of combatting the liquidity trap, we have also reported the Bank of England’s estimate of how quantitative easing had affected economic output or GDP on October 6 2011. The wider point, of course, is that the Bank of England and Fed in the US would not agree we are in such a trap, even if there are some economists who do."

    BBC Trust adjudication, 24 August 2012, Natalie Rose, Senior Editorial Strategy Adviser, BBC Trust Unit:

    "You took issue with the BBC’s responses which variously suggested that the Bank of England and the Fed in the US did not agree with this analysis, that the term itself was too technical to be understood by the general audience and that it was not the BBC’s role to endorse a particular theoretical analysis of the economic situation...the Head of Editorial Standards does not believe that your appeal has a reasonable prospect of success and does not propose to proceed with it to the ESC."

    Makes you proud to have a state broadcaster, don't it.

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    1. Everyone knows the problem is that Labour crashed the economy because of deficits, welfare and taxes, and the bond vigilantes are going to turn the UK into Greece unless everyone licks Osbourne's little ass.

      Everyone knows it. It is a mediamacro fact, not to be disputed or questioned.

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  5. Isn't that the problem of (political, not academic) macroeconomics since the monetarists and Chicago took over? Ever since, the solution to demand side problems were measures that mainly benefit the supply side. QE ensures that the financial sector (pension funds, insurance companies or banks) gets their hands on the money before other people do it.

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  6. What about the moral hazard of giving people something for nothing? Won't they, rationally, stop working altogether?

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    1. The large increase in real wages for the average worker over the last century or two constitutes "something for nothing". The average worker has reacted to some extent by doing less work. I don't see the problem with that.

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    2. actually, as a real conservative, i agree with you and that is why i want to see workfare and not welfare for those who are capable of working. That does not mean that I did not support obama and his fiscal stimulus to get the US economy moving again. I think that is the reason that the US is ahead of GB. Now as to social security and medicare, there is another question.

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    3. You would not giving something people by and large, just take less taxes.

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    4. If the "helicopter drop" were £300bn/£5k per person, say, the 42% marginal tax rate payers would probably not work a lot less. It wouldn't make that much difference. The nil rate taxpayer or "worker" with net tax credits would probably take some time off. Marginally speaking, less work would be done. RGDP would fall.

      And, of course, it would be a one year wonder.

      It's a silly idea.

      Of course, it might appeal to an unscrupulous political type looking for a boost from certain sorts of voters ahead of a General Election.

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  7. My cynical answer to the question Simon puts in his 2nd last sentence is thus. Important people dressed in smart clothes in Westminster and the City of London think that only others of their ilk are responsible enough to handle large amounts of freshly printed money. (You can tell how responsible they are by the fact that they recently crashed the World economy and caused 5 years of excess unemployment).

    In contrast, people living on council estates in Northumberland cannot possibly be allowed to have more money to spend: they’d just waste it on things like more food or heating their houses. I.e. (and contrary to what is says in economics text books), the purpose of the economy is NOT TO provide ordinary people with what they want. The purpose is to provide toys for boys in high places.


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  8. Its unlikely that the CB would make a loss. It only buys assets that its expects to be secure and can hold them to maturity receiving the coupon payments in the mean time. if there was an expectation to the contrary sentiment about QE would be quite different.

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    1. I disagree. Take the example in my first footnote. The central bank is buying assets currently worth £200, but with a maturity value of £100. All interest payments are being passed straight back to the government.

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    2. I expect there is some flexibility in how much of the interest payments are paid to the government . Yes that is a big difference in the footnote example.

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    3. > Simon.
      I just re-read the footnote. As you say that only applies to a bond with a very long maturity. I expect the purchase decisions of the Central bank take that into consideration. Yield to maturity.

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    4. If you assume that the central bank only buys short dated bonds and never buys negative yield bonds, I don't see how it could lose money. There would always be less money in the system once the bonds expire. As you take rate risk you can lose money, but that's a different matter. But the goverment takes the opposite rate risk most times, so I am not sure it's really risk increasing overall.

      Also as long as QE is less than gross issuance, I am not sure you can have a real loss as well. The central bank could buy bonds directly at auction (or shortly after). How would insurance companies benefit from that? I guess the financial sector would get some transaction fees, but that's not much. The central bank is basically always buying from the government more or less anyway. The fact that the financial system holds the bond for a bit doesn't alter that reality that much (unless the CB is buying in an inefficient way, which is a separate issue and which could be solved).

      A successful QE program should raise interest rates (either through inflation or real rates). That can't be good for fixed income holders.

      I also think you need some strange expectation model for mean-reverting money demand shock to affect long terms yields in any significant way as well.

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    5. If the central bank buys government debt when interest rates are low, and sells when they are higher, how can it avoid a loss?

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    6. "If the central bank buys government debt when interest rates are low, and sells when they are higher, how can it avoid a loss?"

      Well the duration will be different. If the CB buys a 10-year bond and sells it six years from now, it will be selling a 4-year bond. Interest rates may be higher, but the CB's profit-loss is more complicated than this simple fact, and depends on what happened in the 6-year interval.

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    7. Why? Remember all interest on QE assets in the UK and US is passed straight back to the government.

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    8. Unless you buy more bonds than gross issuance, on a consolidated basis you are buying them from the government, not from the private sector. So the central bank would lose money, but that money would go to the government. Unless you care between which bit of the government (since the gov owns the cb). I don't see the difference.

      Obviously the CB doesn't bid at government auctions, but unless they buy then bonds very badly, the actual yield only matters to determine the price of an internal transfer effectively.

      In addition, I don't think it's reasonable to expect velocity shocks to be mean reverting. If you did, long term bonds wouldn't change in price/yield, and a cb buying very long dated bonds would have no rate risk (as very long term rates would be fixed or uncorrelated to cb actions anyway). So it couldn't lose money on the trade in expectation.

      Do you think someone is poorer when the stock market goes up? It's not a zero sum game....

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    9. If the CB financed were effected by rates changes do you not think that the interest passed to the treasury would be moderated and some kept by the CB

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    10. All income generated by QE assets should surely be included in the calculation. If the central bank buys a bond for 105, receives 10 in interest and sells it for 100, it made a profit. There will be less money in the system than before, since it effectively paid 105 and received 110. I don't see how you could make such a transaction a subsidy to the finance industry.

      I don't think you can say it lost money on the transaction.

      Only if you buy at negative rates, you are than guaranteed there will be more money in the system at the end.

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    11. "Why? Remember all interest on QE assets in the UK and US is passed straight back to the government."

      Then I have no idea what you mean by profit or loss, since if you ignore interest paid, there is very little sense left in these notions. It's much like saying, let's see if this business is making money, but we will ignore how much interest it is paying on its debt.

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    12. But the debt does not yield any interest while it is held by the CB. If you are so sure about this, why did the Bank of England get the UK Treasury to promise to cover any losses on UK QE?

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    13. Why? Because they might make a loss, not that they would make a loss. There's a different between the modalities of possibility and necessity.

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    14. I have no idea why they requested the guarantee from the treasury. You should ask them. Maybe because it doesn't cost anything and it would silence some critics...

      I don't really understand how you can justify saying that he debt doesn't yield any interest. Could you explain that? I mean it's a bond, it pays interest. Why is the CB not entitled to it? How is the government worst off if it has to put back some of the dividends it received from the central bank. It makes no sense to me.

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    15. It gets the interest, and pays it back to the government

      http://www.bbc.co.uk/news/business-20268679

      If you like, you could rewrite what I wrote as 'central bank gives interest on QE assets to government, so why not print money to fund fiscal stimulus instead?'

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    16. Returning those interest payments is not the same as printing money. It just makes the transfer neutral.

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    17. and your accounting needs to acknowledge that QE has been relieving the government of the burden of those interest payments.

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    18. I personally think the CB was already partially printing money to finance fiscal stimulus. So you could argue that it could restart doing that and do more.

      This is not at all related to the argument you made about the money going to pension fund/wealth/finance sector. I would argue it's exactly the opposite. If the CB is already financing fiscal stimulus by waiving interest on government debt it bought, it's likely taking that wealth from holders of nominal assets. Giving money to A is not usually a sign you are giving money to B.

      I actually agree that money financed spending can be useful. I just disagree that the current implementation of such policy (gov deficits plus QE) is at all different from what you advocate. If you only bought t-bills on a revolving basis and the government started issuing more short dated debt, it would be identical. I doubt purchase compositions makes such a big difference.

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    19. I don't, because it makes no difference to my argument. Why is creating lost of money for QE considered OK, but creating much less and giving it directly to the government considered taboo?

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    21. Because QE is not printing money in the sense you are using it there. It swaps one asset , a Bond for another a reserve. If it was referred to as bond holder giving the CB a Bond for safe keeping and receiving a receipt, a reserve entry, it would be less controversial.

      The answer is that if it goes to plan no extra money is left outstanding. Its neutral .

      So your question is a non issue in the face of the path that QE is supposed to take. You have created your own particular contrived scenario that the economic discourse has not heard of and then you ask why aren't people talking about it.

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    23. I think the premise of the question is unfounded , both scenarios are taboo. You must have heard the opprobrium of "bankers" in the popular discourse since 2008. If QE did result in a transfer to the private sector like you have in that scenario that would also be considered taboo.

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    24. If there is profits to be made doing QE, the private sector will do it!! It will be via credit market making use of leverage (in effect increasing the velocity of money). But it's because there is no profits that the private sector is not interested, i.e. there is no incentive for the private sector to do undertake private QE.

      With the velocity of money collapsing in 2008, the stock of money has to be increased to insure that economic activity don't collapse and/or deflation occurs. This requires the govt to do public sector QE, and as SWL shows, it has chosen to do this via the CB and finance sector instead of ordinary government expenditure. There will be losses, and either it is paid for by taxes or the CB will have to pay it back with future profits (when the economy is normal again). The South African Reserve Bank followed the latter approach when it incurred massive losses in trying to defend the ZAR in 1998 (called the Forward Open Book and it took years to pay it off).

      To use the example listed above: a bond with a par value of $100 and 5% coupon rate. If market interest rate on that is 1%, it means the market value of the bond is $500. Under QE, the CB buys it at $500 and holds it for say 2 years until market interest rate is 2% (market value of the bond is thus $250). During the 2 years, the CB has received coupons of $10, and sells the bond at $250, thus making a loss of $230. If the govt issued the bond, they paid $20 coupons and have to cover the $230 loss of the CB. The pension fund received $500 when it sold the bond to the CB and paid $250 for it 2 years later. In the ideal world, the govt should increase the tax on the Pension fund to recover the $250 losses. But in the real world, it would be everyone BUT the pension fund that will be asked to pay more tax.

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    25. the private sector is not omniscent; when there is a panic, many players run for cover rather than making investments that would in the long run make them a lot of money. How about AIG?

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  9. "So why is this considered kosher"

    Well speak for yourself (and other macroeconomists). Many of us don't consider QE kosher.

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  10. You raise an interesting question, Simon, but the premise of your question "why is this considered kosher, but the central bank giving the same amount of money (its loss on QE) directly to the public is considered deeply problematic?" is wrong.

    Central banks would not admit to expecting to lose money on QE. The most legitimate reason for a central bank to do QE, and a reason that even inflation hawks should be able to support, is that the central bank is providing the most liquid and safest of all assets at a time when the market is irrationally fearful of even slightly less liquid and safe assets, and thus the central bank gets paid in terms of an interest rate pickup for doing QE. In other words, the central bank expects to gain a seigniorage profit from providing more money at a time when it makes policy sense anyway to supply to additional demand for money as a safe asset to prevent that demand from interfering with the demand for money as a medium of exchange. By contrast, a helicopter drop involves giving money away, so it will definitely produce a loss for the central bank.

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    1. thats an interesting take on it, providing money to prevent the demand for money from interfering with the medium of exchange, a bank centric policy rather than macro/political policy

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    2. QE is not designed to provide liquidity. It is designed to put downward pressure on long term interest rates. You are right that central banks do not talk about making a loss, but perhaps that tells you more about politics than what they actually expect. The Bank of England did make sure that the Treasury committed to covering any losses it did make.

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    3. "QE is not designed to provide liquidity. It is designed to put downward pressure on long term interest rates."

      There are lots of ways to reduce interest rates that don't help anyone. Surely there's no equivalence between reducing rates by supplying liquidity (i.e. pushing the market toward equilibrium) and reducing rates by removing liquidity (i.e. pushing the market away from equilibrium).

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    4. "QE is not designed to provide liquidity. It is designed to put downward pressure on long term interest rates."

      It was at first, but the rationale for QE varied as the BoE wanted to keep it going. As I recall, the initial justification was to increase base money, and then broad money by favouring gilts likely to be held by non-banks, and only later was the justification lowering long term interest rates.

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    5. Simon - I've often heard economists say stuff like this: "QE is not designed to provide liquidity. It is designed to put downward pressure on long term interest rates" but I find this strange.

      As I understand basic monetary policy: central bank buys bonds for cash. Instead of sittting on their bonds for interest, former bond-owners instead use their new stock of cash as reserves for new loans. Interest rates fall (on bonds, due to scarcity, and on general lending, due to increased desire to lend), general lending and liquidity increase.

      If QE (aka monetary policy targetting long term bonds) only drives down interest rate of the bonds themselves, and has no general liquidity effects, what is the point? How is it supposed to be working?

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  11. Is it your theory that the fiscal transfer in your scenario to pension funds is what makes QE work? Because if not, we can just say that in this case the bank made a dumb investment/speculation and lost money. It should have made a smarter investment, or left investing to the private sector.

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    1. No. QE is not designed as a way for the central bank to make speculative profits. It is designed as a means of reducing long rates. There is nothing in this design that stops the central bank making a loss.

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    2. But you're not saying that QE is designed as a way for the CB to deliberately lose money, are you? If the CB is correct that long rates are too high, then it should make a profit. It only loses money if it guessed wrong.

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    3. Yes, I am saying that you would expect the CB to lose money. The CB will not sell when long rates fall. It will probably sell when it has already begun to raise short rates, which will probably mean that long rates are higher.

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    4. Expect to lose money because CBs are stupid or expect to lose money because losing money is how QE works? And if the latter, can you point me to some paper that elucidates the point?

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    5. I am not saying anything controversial here, or anything that macroeconomists would not accept (I think). What is new - if anything - is pointing out that it is illogical to not worry about losses on QE, but then say helicopter money is wrong.

      On losses, see this for example:

      http://www.bloomberg.com/news/2013-02-26/fed-faces-explaining-billion-dollar-losses-in-stress-of-qe3-exit.html

      The report also makes it clear why central banks tend to keep quiet about this.

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    6. rather than withdrawing reserves, the Feds interest rate policy tool can also be interest paid on reserves

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    7. Obviously the Fed will take losses at some point, but they have already registered massive profits from QE (maybe by luck rather than skill, but still). I thought you were saying that QE was expected to lose money from the beginning, not that some of the paper profits will be "given back" eventually.

      The parallel with fiscal policy is deliberately losing money. Not accidentally losing money, or making money and then losing money (with the losses smaller than the gains).

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    8. I'm sure I read somewhere about real examples where central banks had become "insolvent", but where the world didn't collapse. But I can't find the link now. So, I guess my point here is that this isn't hypothetical.

      And central banks usually make a profit in 'normal' times. Is it possible that they would lose more on this QE than they have made in recent decades in profit?

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  12. The idea that QE involves giving money to the financial sector seems to be at odds with Paul Krugman's argument in "Plutocrats and Printing Presses" (http://krugman.blogs.nytimes.com/2012/04/20/plutocrats-and-printing-presses/), where he says that the financial sector hates QE because it compresses the short/long rate spread. Is there an easy way of reconciling this for the lay reader? Both arguments seem to make sense to me.

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    1. They may both be right, because 'the financial sector' is not a single entity. That was partly why I chose the example of pension funds.

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    2. You say that the job of the Central Bank is to control inflation as if that is the only job a Central Bank has ever been needed for, but high inflation is a relatively new phenomenon that only got really bad in the C20th, since when it seems all Government's policies have revolved around controlling inflation, sometimes at the expense of growth.

      Did Central Banks never have any other purpose beyond inflation? Do they now? It does seem to me that if they have, it has been forgotten.

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    3. "high inflation is a relatively new phenomenon that only got really bad in the C20th"

      With some early exceptions (e.g. during the later days of the Roman empire and at times during the Middle Ages) long-run inflation only became a thing around the time that central banks started to gain lasting independence from the Gold Standard. It only became a real problem for countries like the UK once we abandoned the dollar constraint, starting with devaluation in the late 1960s and then even moreso after leaving the Snake in June 1972.

      So we're left with two alternatives: central banks like the Bank of England in the 20th century sincerely wanted to not have high inflation, but failed to control their domestic price levels because of political pressures and just plain mistakes, or it was a deliberate policy move. I think it was the former.

      Now the line is moderate inflation, but the Fed, the BoE and especially the ECB is failing at even that goal.

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    4. Krugman made that up, because he advocates QE and he needs to dispel the idea that it is a bailout of the financial sector. But it is - the financial sector loves QE, because QE inflates risky asset prices, which has allowed them to avoid realising losses on the risky assets that they held when the music stopped in September 2008, and is now allowing a revival of buy-side interest in those markets, which are very profitable for investment banks, from structuring such securities and trading them at wide spreads. At the risk of sounding like Kevin Keegan, they LOVE it.

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  13. The FED has a dual mandate of controlling inflation and ensuring full employment.

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    1. The Fed's real mandates are pushing up asset prices and ensuring that no banks fail. Via greenspanian "balance sheet" "systemic safety" sophistry they claim that the real mandates coincide with the official ones.

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    2. «pushing up asset prices»

      To be more technical, their real mandate is to push up *collateral* *valuations*, because their current main role is to expand the debt-collateral spiral as much as possible, because without ever higher collateral valuations ever increasing debt cannot continue to be rolled over.

      This is what Greenspan and central bankers mostly mean when they talk of "balance sheet repair".

      «and ensuring that no banks fail»

      That should be "no major banks fail", as some minor or middling banks are occasionally thrown under the bus to show that the system is not rigged :-).

      Rising collateral valuations allow for covering losses on already issued debt and making booking more front-loaded phantom profits on new debt, so it achieves at zero current cost "balance sheet repair" and protection and expansion of banker bonuses.

      Collateral and rehypothecation of collateral and front loading of revenue and back loading of costs and the debt-collateral spiral are the much underknown strategies of current finance. But most central banks are not stupid and know that very well, so almost everything they do is designed to keep those strategies going.

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    3. lehman fell, and it was a big and important bank.

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  14. Sure it would be nice to fix the economy, but think of the consequences: we'd have to give money to poor people!

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  15. "QE in this case involves the central bank giving money away to pension funds. So why is this considered kosher, but the central bank giving the same amount of money (its loss on QE) directly to the public is considered deeply problematic? [2] Why would it be thought completely wrong for the central bank to voluntarily give the same amount of money to the government so that they could help stimulate the economy by some fiscal means (a money financed fiscal stimulus)? [3]"

    Wonderful proof that QE is not kosher.

    Both the posts and the comments remind one of discussions how many angels can sit on the point of a pin.

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  16. The US experience is not consistent with the view that the central bank should expect to make a loss on QE. Indeed the Fed really seems to have quite a racket going. When it buys bonds, people start to expect recovery and inflation and are eager to sell their bonds to the Fed. Then it stops buying bonds, expectations of recovery and inflation start to weaken, and people are eager to buy bonds, which gives the Fed a capital gain (at least on paper, if it were to mark up its portfolio to market value). The Fed has managed to pull this trick three times in a row: it's pretty amazing.

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    1. explained by rational expectations and efficient market hypotheses no doubt.

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    2. Good point, also it has been observed that after Fed QE periods were announced and during the QE periods bonds dropped.

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  17. Market Fiscalist20 January 2015 at 20:12

    Not sure if affects the argument that much but its not just the pension funds who directly trade with the CB that gain. Anyone who holds govt debt can sell it high and buy back low in the scenario described. (And as private debt probably moves in alignment with public debt anyone who owns private debt probably can too).

    In fact is it possible that the expectations that asset prices might eventually fall when interest rates return to normal that may drive the large cash balances people currently like to hold ?

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  18. The main argument against helicopter money is that it is against the nature of capitalism to give somebody money he hasn't work for.

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    1. That is with odds approving tax cuts though.

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  19. Saying the same thing as Simon (I think), but in a different way: if central banks were in the business of maximising profits for their shareholders (the government) they would act in a very different way, even if they had a fixed long run price level target. Anything they do results in a fiscal transfer, relative to that profit-maximising policy.

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  20. «The central bank creates money to buy government debt in the market at a time when that debt is expensive, because it only does QE when interest rates are low. »

    A model like this in which interest rates are endogenous is inconsistent, and anyhow interest rates are not endogenous...

    Fortunately the following discussion about the distributional impact of open market operations probably does not depend on such a flawed premise.

    After all the argument is based on the simple premise that after all the *goal* of QE is to raise security prices by having the bank pay for them more than "the markets" would.

    With that kind of premise it is pretty obvious that the distributional impact is likely to be from people short securities (e.g. taxpayers) to people long securities (e.g. the tax-avoiding rich), because that distributional impact is in effect the goal of the policy.

    Unless it is countered by some policy of opposite distributional impact, like taxing those long securities more than those short securities; but that can reduce the incentive to hold securities, and thus depresses their price again, while policies like QE are aimed at higher security prices.

    Also I note that our blogger can no longer claim to be a Serious Economist :-), because he has discussed and even *in public* the distributional impact of policies, that is "class war", and Serious Economists never support or even mention "class war" topics like distributional impacts.

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  21. «QE is not designed as a way for the central bank to make speculative profits. It is designed as a means of reducing long rates.»

    The latter point reads a lot more meaningfully if it is translated to "It is designed to push up the price of long term securities by paying subsidized prices for them (especially those that 'the markets' don't want to buy)".

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  22. Possibly a stupid question but I suspect a pretty common one.

    What if the government does not recapitalize the CB? Can it not operate with negative equity?

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    1. Not a stupid question at all. Some argue that it needs assets to sell so it can raise rates and take money out of the system when need be. If it ran out of assets before interest rates had reached their required level that would be a problem. Others argue that in that case the central bank could still withdraw money from the system by (a) raising bank reserve requirements, or (b) issuing assets itself.

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  23. I am not sure that QE necessarily implies any loss on the CB's part. If the CB wishes to increase the money supply for a period of 5 years, it should purchase 5 year bonds, ideally directly from the government. If it does this and holds the bonds for 5 years and simply lets them mature, the money supply after maturity is the same as what it was prior to the QE program, and there are no CB losses. Further the government has the flexibility to decide how to distribute the money at the beginning and how to tax it away at the end.

    Operationally, QE programs have been implemented by purchasing bonds from the market, but this is mostly I think due to legal restrictions on the CB directly purchasing government bonds. As far as actual effect goes, I don't think there is any difference.

    If the CB ends up having to sell the bonds it purchased prior to maturity, because money supply seems too high say two years in, that means it mis-estimated the amount of time for which the money supply would have to be increased. The sale is a new round of CB policy -- it might help to keep things straight if we consider it as a separate short sale of new three year bonds. i.e. the CB issued $100 in money by purchasing 5y bonds initially, two years in, it reduces money supply by $100 by short-selling 3y bonds. At the end of 5y, both trades mature and offset each other. The only net effect is some small amount from the coupons of the two bonds not canceling each other. If we assume that interest income is simply remitted to the government (which sort of requires the opposite assumption that negative interest income will require the government to "pay" some money back to the CB, though this is probably unlikely since in practice most CB's will not end being net short bonds), this has no effect on the money supply.

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    1. To add, it is certainly true that the CB suffers mark-to-market losses (or gains) during those 5 years. However, there is no way a CB can be forced to realize those losses, unlike a private financial institution, so the mark-to-market view is not really relevant.

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  24. I apologise if this has already been answered implicitly, but does the whole argument explain why the SNB scrapped its cap? I believe they were worried about losses they might make on Euro-denominated assets, but please correct me if I'm wrong.

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  25. I think this is the best blog I have been through all this day. financial news

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  26. I don't think this is quite right as it ignores the profits flowing to the public sector for the duration that the bonds are held by the central bank (ie Seignorage). Thanks to QE, the government saves on paying interest payments to the private sector. So even if it's the case that the value of the bond is higher when it is sold (which is not necessarily the case, even if rates have gone up, as a finite-maturity bond represents a smaller total cashflow as time goes by), this does not mean that the public sector will realise a loss overall.

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  27. A very best chance to get involved with such cases.

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