Quantitative Easing for Dummies

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Will

Will writes from Washington, D.C. (well, Arlington, Virginia). You can reach him at willblogcorrespondence at gmail dot com.

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15 Responses

  1. The problem with Rube Goldberg economics is that human society is not a deterministic system.Report

  2. Avatar Barry says:

    Christopher, we’ve made much progress in handling non-deterministic systems since you were a classical physicist back in the 1800’s. You might want to check it out.Report

  3. Barry, did you also predict the economic crisis? Last time I checked, teacups remained teacups despite Schrodinger, but the macroeconomy continues to defy our best and brightest.Report

  4. Avatar Boonton says:

    Not a bad summary but there’s a few points where I would depart:

    1. I don’t buy the ‘gamble’ that QE will ignite bubbles. This is a common Austrian claim, but I don’t see a good argument for a mechanism other than “cheap debt”. Why would being able to borrow at 2.75% instead of 3.5% suddenly cause you to act like an idiot?

    2. QE has a ‘self destruct mechanism built in. When the Fed buys a 5 year bond it gets coupon payments every 6 months and at the end of 5 years the principle of the bond. If for some reason the Fed decides that too much cash is in the economy, it just has to sit back and do nothing as the bonds mature. Or if it wants to pull cash out even sooner it can simply sell the bonds.

    This stunt is no so easy if you’re dealing with long term bonds like the 30 year where the price can go up and down a lot. In that case the Fed may find that it couldn’t sell a 30 yr bond for as much cash as it created when it used QE to buy it.Report

    • Avatar Will in reply to Boonton says:

      @Boonton, Isn’t there some empirical evidence for the bubble hypothesis? I think Krugman described a connection between the post-tech bubble expansionary monetary policy and the housing crisis.Report

      • Avatar JosephFM in reply to Will says:

        There is, but right now inflation is below where it needs to be to simulate spending now rather than later. If the policy is still in place after that, then you can worry about bubbles. Right now, both economic growth and inflation are practically flat, which is all the evidence of a non-bubble that anyone needs.Report

    • Avatar Mike Schilling in reply to Boonton says:

      @Boonton,
      Why would being able to borrow at 2.75% instead of 3.5% suddenly cause you to act like an idiot?

      Financial types are idiots. Cheap money means more opportunity to be idiotic. Sufficiently cheap money means enough concentrated idiocy to go critical, like when enough plutonium atoms get together.Report

  5. Avatar Francis says:

    We are already in a bubble for federal bond debt. People are irrationally(?) scared of the private market, so they are buying so much federal debt as to drive yields to zero. The Fed is going to take advantage of the bubble by buying T-bills for itself. This will hopefully drive yields so low that people finally start moving back to private debt, driving down the cost of borrowing in the private market. Because t-bills are highly liquid, if people start exiting the federal market faster than expected, the Fed simply sells is T- billion the open market, increasing supply and driving yields back down.Report

  6. Avatar Barry says:

    Christopher Carr says:
    “Barry, did you also predict the economic crisis? Last time I checked, teacups remained teacups despite Schrodinger, but the macroeconomy continues to defy our best and brightest.”

    No, but why would that matter? If a crisis with a known cure presents itself, would you expect that only those who directly predicted it would have advice of value?

    Also, if we apply your criterion, that wipes out just about every single right-wing economist on the face of the Earth – not only did they not predict it, but they then spent the next few years making BS predictions.Report

  7. Avatar Frank says:

    I still want to know what the heck quantitative easing is. Is that too much to ask?Report

    • Avatar Boonton in reply to Frank says:

      When the Fed wants to lower interest rates it buys 3 month Treasury bonds. It does that by ‘creating’ money. When it wants to raise interest rates it sells 3 month Treasury bonds, thereby ‘destroying’ money.

      Quantitative easing means that it buys something other than Treasury bills. That could be other types of Treasuries like 10 yr bonds, it could be non-gov’t bonds like bonds backed by car loans or mortgages. It could be shares of stock.

      The danger/issue with this is that it lowers the Fed’s power to destroy money should inflation come. If you brought a 3 month Treasury bill for $990, you can always sell it later for a bit more than $990 thereby getting the cash back. Anything else and you’re at the mercy of whatever the market price is. That’s the con of QE.

      The pro, though, is the same thing. When the Fed does that, it says its really stimulating the economy and investors can trust that. With regular buying of 3 month Treasuries, investors know that the Fed can turn around at any time and easily raise interest rates and destroy all the money they created in less than 3 months.Report