Winner of the New Statesman SPERI Prize in Political Economy 2016

Wednesday, 2 September 2015

Corbyn, QE and financial interests

Although this uses UK events as a spur, the point about QE is universal

Labour leadership candidate Jeremy Corbyn has shown some flexibility on his idea of People’s QE. That is perhaps a good sign for the future (if he wins), in terms of responding to informed criticism. As I have written before, the original proposal took two perfectly good ideas (we can do better than current QE, and the need for a National Investment Bank) and combined them in an unfortunate way. I was annoyed that this proposal had been made public with so little consultation, and that as a result it might discredit both of the two good ideas. Perhaps more optimistically it will instead spark a debate on each individually.

Here I want to talk about Quantitative Easing (QE). The basic idea behind QE is that by buying long term assets at a time when their price is high (interest rates are low) to make their price even higher (interest rates even lower) in the short term, and selling them back later when asset prices are lower (and interest rates higher), you could stimulate additional demand. At first sight it seems not too dissimilar to a central bank’s normal activities in changing short rates. There are however two major differences. The first, which in principle does not matter too much, is that the amount of money you create to ensure short term interest rates fall is modest. The amount of money you have to create to have any significant impact on long rates is much greater.

The second more important point is predictability. The central bank can have a large and fairly predictable influence on short term rates in the market. The impact of any amount of QE on long rates is much more uncertain, both in theory and in practice. Worse still, because its impact depends on certain institutionally specific market segmentation, or some very time specific signalling, and may also be quite non-linear, there is no reason to believe that any knowledge gained this time round will still be relevant the next time the instrument is used. In short, it is a lousy instrument.

That should mean that everyone is looking around for a better way of doing things when short rates hit their lower bound. Fiscal stimulus is the obvious candidate, but we know the political problems there. If you want to be kind, you can say that they illustrate the difficulties of apparently delegating stabilisation policy to a central bank, and then telling politicians that just when stabilisation is most needed they have to do it themselves. For that reason helicopter money is not just fiscal stimulus by the back door (and if the central bank is always underwritten by the fiscal authority, that could be all it is), but a means of giving the central bank the tools to do its job effectively whatever the size and sign of shock.

In the absence of an appropriate government fiscal policy, I find the logic for helicopter money compelling and the arguments against it pretty weak. But just as with fiscal policy, just because something makes good macroeconomic sense does not mean it will happen. I have always been reluctant to pay too much attention to the distributional impact of monetary policy, because it seemed like one of those occasions when even well meaning attention to distribution can mess up good policy. Yet in terms of the political economy of replacing QE, perhaps we should.

It is more likely than not that QE will lead to central bank losses. By this I mean that the central bank will have less money than if they had not undertaken the policy: whether they actually have to be recapitalised by the government is not the key issue here. After all, they are buying high, and selling low. That is integral to the policy. Who gains from these losses. Where does the money permanently created because of these losses go? To the financial sector, and the owners of financial assets (who are selling to the central bank high, and buying back low). In that sense, likely losses on QE will involve a transfer from the public to the financial sector.

If QE was the only means of stabilising the economy in a liquidity trap, because fiscal policy was out of bounds for political reasons, then so be it. The social benefits would far outweigh any distributional costs, even if the latter could not be undone elsewhere. But if QE is a highly ineffective instrument, and there are better instruments available, you have to ask in whose interest is it that we stick with QE?      

32 comments:

  1. I seem to be in a decided minority on this, which should probably tell me something, but I think there is potential for PQE also to be used as fiscal stimulus by the back door, which happens to be more or less the exact phrase I used in the final paragraph of this post at Coppola Comment (that gave Murphy an attack of the vapours).

    You recognise the evident political difficulty of delivering fiscal stimulus in general and investment spending in particular, just when it is most needed. There is also obviously an appeal to PQE in that it superficially looks like spending without borrowing (even though, as I argue in that post, which is really just a restatement of the point that an inflation targeting CB cannot commit to permanent monetary expansion, it really isn't) which might prove helpful from a political perspective, and if reserved for use by the BoE at moments when deflation is more of a worry than inflation, I still think it could be helpful in a very second best sort of way.

    What I have in mind really would be ridiculous, in that a National Development Bank could probably tap capital markets and fund an expansion of activity if it wanted to, in any case. But some bond purchases by the BoE earmarked for public investment might look good and make the whole thing (sustaining or increasing public investment at times of recession) easier to pull off.

    Put it this way, if the BoE was to purchase bonds issued by an NDB at times of recession and the NDB was able to deliver an associated boost to public investment (relative to the counter-factual, not necessarily in absolute terms) would that be a bad thing? Yes in time the BoE would probably sell those bonds into private hands, one way of another, and hence the spending would end up being debt financed in the long run, but so what? I mean at least the idea of PQE is out there and has some popular support, so politicians could run with it, and transforming it into a counter cyclical tool along the lines that I describe that should win support from more mainstream economists. Helicopter money might be the better idea, but it's outside the Overton Window, isn't it?

    Paddy

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    1. Could a similar device be used to appease bond vigilante fears and/or encourage confidence fairies.

      Say you hit recession and debt goes up, sparking fears similar to the last recession, which, legitimate or not, ultimately lead to bad policy. The central bank could use PQE to print money to reduce national debt and/or the deficit.

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    2. Paddy: your reasoning is correct, which is pretty well what I said here:

      http://mainlymacro.blogspot.co.uk/2015/08/peoples-qe-and-corbyns-qe.html

      The mistake that was made was to suggest that something that should be funded anyway should be funded by the Bank using a tool they only used in extremis, and were not using now. So it looked like an attack on central bank independence, which was foolish in terms of the economics and politics.

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    3. Thanks for response Simon.
      Paddy

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  2. I don't really agree with both points to be honest. I am not entirely sure QE is expected to lose money. It's true that prices will likely move against the bank, but bonds pay interest as well and I don't think it's obvious that income is not enough to counterbalance the capital loss. I think as long as the IRR is zero, you cannot really say the bank has lost money on the trade, there is no equivalent of a hurdle rate (or the hurdle rate is zero).

    Second even if there is a loss, I find it difficult to think the financial sector will really benefit. At the end of the day the central bank is demanding more bonds: bonds are produced by the government, so the first order effect would be a reduction in the interest rate paid by the government on new debt. It really depends on the average maturity of government debt. If the debt is very long before QE, there might be an actual loss for the government sector as a whole... Given the debt profile of the UK (which is fairly long), it might be a problem, but I think it's still reasonable to think that the main benefit accrues to the state in the form of lower (or even negative) rates on new issued debt.

    Finally it really depends on your definition of financial sector. If you include the pension industry, then sure you are probably right. If you mean banks and brokerages and the like, I don't really think so... Banks mostly make money from credit, and improving the economy will help bank profits, but lower rates by themselves I don't think so... Banks don't hold huge amounts of outright govt bond, most are hedged... I think it's likely that high net worth individuals will benefit, but the financial secotr as such not so much. Profitability is more linked with volumes usually and QE tends to depress volatility which reduces profits. It's not clear at all...

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  3. Answer to your questions were given right at the begining of implementing of QE1 in USA by FED chairman when he explained it. It was a continuation of eforts by FED to keep banks afloat after Lehman and AIG.
    TARP, PPIP, MAIDAN LANE then QE are doing the same thing but in ever increasingly stealth way to save banks. TARP was too obvious and open so it created revolt by people in both sides of politics.

    It took you 4 years to figure out what QE is, stealthy SOB isnt it.

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  4. Love your description of the previous delegation of stabilization policy to central banks, and now impotence of their policies, even QE, but difficulties in telling the public (politicians?) this, while fiscal policy has been forever immobilized theoretically and practically with fiscal rules. Hillarious, but v sad situation

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  5. "Fiscal stimulus is the obvious candidate, but we know the political problems there. "

    You can get the effect of the CB doing policy (fiscal or monetary) by abolishing one of the political parties and implementing a one party state that always does the same thing.

    Think about that.

    You do not have the One True Answer. Because you don't and others disagree with you (Steve Keen says "the basics that the mainstream accepts are delusional"), we have parliament to debate and decide what should be done.

    And then a voting system to decide between different *ideologies* (because that's what they are. You are not doing science. You are promoting an ideology).

    Now obviously an ideology will do its best to embed itself permanently. But the system should be set up to resist that and promote competition between different viewpoints.

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    1. Well of course all economic theories are "ideologies". Even ones that claim to be science.

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    2. Hmmm, by conventional use it's only really an idoelogy if it's something that has certain degree of irrational commitment. Thatcherism, MMT etc.

      But perhaps that does cover all economic theories

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    3. «get the effect of the CB doing policy (fiscal or monetary) by abolishing one of the political parties and implementing a one party state that always does the same thing.»

      Amazingly this may have happened in practice since 1997: both parties have used credit and monetary policy to boost leverage and asset prices as much as possible while using other policies, including immigration, to hold or even push down wages. Then there have been some substantive differences at the margin, but the main goals have been similar, because both parties have been appealing to the same constituency of middle-income rentiers in the South East.

      «You do not have the One True Answer. Because you don't and others disagree with you»

      This seems to me clever sophistry, prevaricating between having different answers on the best means how to reach a given goal and having different goals.

      If the disagreement is about, given a goal, how to reach it (given constraints), some answers will be wrong, and some will be right, and that will just be it. There can be in that case One (or Some) True Answer, even if it is hard to prove that.

      «we have parliament to debate and decide what should be done»

      That seems quite incorrect to me: parliament and politics is about mostly what should be *achieved*, rather than what should be *done*; the latter is often a matter of implementation left to "experts", however funny their recommendations turn out to be. Political discussions are not in principle about «what should be done», they are about the ends, not the means.

      Sometimes it is a bit dangerous for politics to be too involved about the means, because that usually is still about the ends, but in a covert way. But then most means have very different impacts as to the end...

      «You are not doing science. You are promoting an ideology).»

      If one is discussing which means are valid or best for a given end that's not promoting an ideology *necessarily*. SimonWL seems to be discussing means, that is "instruments", not ends, as in his conclusion:

      «If QE was the only means of stabilising the economy in a liquidity trap, because fiscal policy was out of bounds for political reasons, then so be it. The social benefits would far outweigh any distributional costs, even if the latter could not be undone elsewhere. But if QE is a highly ineffective instrument, and there are better instruments available, you have to ask in whose interest is it that we stick with QE?»

      Yes for the sake of argument here he is assuming that «stabilising the economy» is an agreed and desirable end, but no party campaigns on an instability and misery platform, at least overtly :-).

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  6. If the central bank was to implement a PQE policy, would infrastructure spending or just crediting people with the money be the more effective? Or is the infrastructure spending idea just part of the confusion between an investment bank and PQE?

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  7. It was noticeable how quickly the BBC and other media outlets came to the view that QE was too difficult to explain - and that the BBC was certainly not going to try!

    Tongues are silver but silence is golden, as Miss Jean Brodie said.

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  8. Strange. I always believed the idea behind QE was to inject money into the system to stimulate nominal demand. Is that not the core idea behind QE and monetary policy in general? Any "loss" is simply permanent injection of money. You purchase longer dated securities because you don't want to continuously roll it over. If it helps to stimulate demand for loans, etc., that is an added bonus.

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    1. Any loss is indeed a permanent injection of money. So why are losses on QE thought acceptable, but helicopter money out of the question. Is it about who the money goes to? That is the question addressed in this post.

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  9. The good thing about QE, helicopter money and People's QE/democratic helicopter money is that it sidesteps the Austerians and deficit fetishists. They're the reason why fiscal policy is blocked.

    My preference is for PQE first, helicopter money second (or how about a combo?) and Banker QE last.

    I don't know about the UK, but in the US, QE was done in the weakest possible manner. Another option is for a stronger more robust QE combined with a higher inflation target?

    Instead of announcing that they'll buy such and such amount of assets each month and see what happens, what if they follow what they do with short rates?

    What if they say we'll buy enough each month until long term rates are at .5 percent or mortgage rates are at .5 percent.? That would give the game away about the government setting long term rates. Only the bond vigilantes are allowed to do that!!!

    About distributional impact, once QE achieves full employment and rising wage inflation, the distributional impact will be much better as workers gain bargaining power.

    They did weak QE which helped discredit it. Just enough to avoid deflation - see Europe - but not enough to tighten labor markets quickly and return NGDP back to trend.

    It's analogous to Obama's stimulus. It was enough to turn the economy around but not enough to spark a robust recovery. And so it was easily discredited.

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    1. «The good thing about QE, helicopter money and People's QE/democratic helicopter money is that it sidesteps the Austerians and deficit fetishists. They're the reason why fiscal policy is blocked.»

      Is it then a political scam? Here you seem to be assuming that a majority of voters is against expansionary fiscal policy, and an enlightened minority of philosopher-kings should then deceive the majority of voters.

      But democracy is not subject to the condition "the voters will matters, but only when it agrees with the decisions of us, the wise philosopher-kings".

      If the majority of voters, for whatever reason, want austerity and deficit fetishisms, and want to block fiscal policy, they are sovereign and it is their right to suffer the consequences.

      In the present case the majority of voters arguably don't want to pay more taxes now (tax funded public spending) or in the future (borrowing funded public spending), however misguidedly, and seem to prefer policies that give effort-free tax-free money to the wealthy (property owners for example), or other policies that seemingly have no direct cost for them as individuals, like QE/helicopter money.

      «once QE achieves full employment and rising wage inflation, the distributional impact will be much better as workers gain bargaining power.»

      That assumes that QE main effect is on domestic production and not asset prices, and that immigration and imports from low wage countries don't rise or not enough.

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    2. This is a lopsided analysis.

      1. The voters have already been deceived by one side about the pros and cons of borrowing AND normal QE.

      2. If PQE, helicopter money or whatever were put to the public in a similarly deceptive way that would simply even things up.

      3. PQE, helicopter money or whatever might be put forward with out any such deception.

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    3. If the central banks' role was to do what the majority of voters want then we'd have a pretty wild ride - Minsky's Marvellous Pro-Cyclic Rollercoaster might be a good fairground attraction style moniker .. not sure if Minsky would approve though ;-)

      T

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  10. "It is more likely than not that QE will lead to central bank losses."

    Why would any sane person choose to crystallise these "losses", when the sale of the bonds is entirely optional.

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  12. You're missing the income earned on the bonds in the mean time. The Fed sent nearly $100bn to the Treasury last year, thereby reducing the budget deficit by the same amount. Since QE started it has probably transferred $600bn to the Treasury between 2010 and 2015. That will rise to nearer $800bn before it begins selling any assets in 2017.

    Even then it has already promised to hold on to the MBS to maturity - it will make a profit on those because they were bought below par. Unless you think US Treasury yields are going to 10%, the Fed isn't losing any money on QE.

    http://www.federalreserve.gov/newsevents/press/other/20150109a.htm



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    1. «the income earned on the bonds in the mean time»

      Oh please! That's just an accounting illusion.

      Besides income, in the aggregate, at the macro level, where governments properly operate, is "earned" by producing tons of stuff or thousands of hours of services, not by bonds. That's what government policy is all about: creating the best conditions for production to happen.

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    2. O my o my, you are forgeting why those assets fell in price and FED had to buy them to save banks. It was the firesale and what triggered the firesale? Bad assets, specifically MBS . Man of underlying properties have been forclosed with loss.
      And why FED will keep them to maturity? Because the are wothless assets.
      Why they still generate income?
      Because it is extend and pretend that they are valued as face value, not at market price so that would be discovered if FED sells it before maturity.

      But, FED can simply erase all loses from QE without recapitalizing at maturity instead of redeeming them.
      I believe that is the plan. Besides they would destroy the banks by trying to redeem asets bought from banks which would defeat the purpose of TARP, PPIP,..QE.

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    3. Maybe the Fed made a profit

      https://flipchartfairytales.wordpress.com/2015/08/21/bank-bailouts-why-the-us-made-a-profit-and-the-uk-wont/

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  13. «In the absence of an appropriate government fiscal policy, I find the logic for helicopter money compelling [ ... ] I have always been reluctant to pay too much attention to the distributional impact of monetary policy [ ... ] in terms of the political economy of replacing QE, perhaps we should»

    As I read this I am very pleased, because of the open recognition of the fiscal and distributional impact of certain types of central bank intervention, and even the use of the "forbidden" term "political economy".

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  14. If QE works the way you describe, then it is indeed a lousy instrument, if it's even an instrument. Does it, though? There are other plausible explanations. For example, that QE works by revealing information about the central bank's intentions. They seem to take some care in their purchases not to affect bond prices any more than necessary. (And by the way, the Fed has logged massive profits - yes, perhaps by dumb luck, but still).

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  15. "(And by the way, the Fed has logged massive profits - yes, perhaps by dumb luck, but still)."

    Isn't that a sign of failure?

    My vote for PQE too.

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  16. So let me get this right. Even though QE has not had much effect except help the financial sector and boost financial asset prices; given the lack of fiscal stimulus, it is better than nothing. Great!

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  17. IMHO Central Bank "independence" should be rephrased as "a 2nd opinion or filter about whether Treasury's wishes for monetary financing were well-deserved by actual macroeconomic conditions, i.e. if fiscal policy shall be enhanced during non-inflationary recessions or curtailed when near full-employment.
    That is quite different, if not opposite, to talk in terms of "delegating stabilisation policy to a central bank, and then telling politicians that just when stabilisation is most needed they have to do it themselves". Because if public debt variation pertains to the Legislative branch while its composition between the monetary base & interest-bearing liabilities is subject to the central bankers' judgement; hence giving power to these latter to decide over the amounts of total public debt would eviscerate both the Legislative & the Central Bank from their primary duties and the whole system of "checks & balances".
    Politicians should not be tame in their actions & central bankers should not be unwise, either to foster expansion or avoid overheating, whenever was needed.
    To refrain from open public discussion fiscal policy matters, just to confine them into enclosed committees would be an ill-advised way to take out politicians' accountability.

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  18. I am not an economist but am really trying to keep up. I find this blog immensely useful. Still, the following sentence defeats me.

    'The basic idea behind QE is that by buying long term assets at a time when their price is high (interest rates are low) to make their price even higher (interest rates even lower) in the short term, and selling them back later when asset prices are lower (and interest rates higher), you could stimulate additional demand. '

    Can anyone unpack it for me?

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    1. If the going rate for a 30 year T-Bond paying 2% interest is X, and the Fed bids $X+1 for it, then the Fed will end up owning that Bond and some institutional buyer now has $X+1 cash to spend on something rather than the $X they might have ended up with otherwise. When the Fed comes to *sell* it's hoard of Treasuries however, that will drive the prices on them down, those seeking low risk low interest bearing assets will slowly hoover them up, and as a result there will be less money sitting around looking for something to buy, and as a result of *that* asset prices would go down across the board.

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