In yesterday’s Financial Times, Jörg Bibow addressed Mario Draghi’s recent announcement that the ECB will take new steps (including cutting its deposit rate to -0.1 percent) in an attempt to deal with (or, one might argue, in an attempt to appear to deal with) the fact that inflation in the eurozone is too low, according to the ECB’s own alleged target.

For Bibow, the proposed measures are unlikely to get the job done, and the same could be said, he argues, for any last-ditch attempt at quantitative easing (a prospect mentioned by Wolfgang Münchau in his last column). The problem is that it’s hard to characterize eurozone disinflation as some unforeseen bump in the road:

The driving force behind the eurozone’s disinflation process is wage repression – exercised to a brutal degree across the currency union. In fact, wage repression – joined by fiscal austerity – is the eurozone’s official policy meant to resolve the euro crisis … With wages in übercompetitive Germany creeping up at a mere 2 to 3 per cent annual rate, the rest are forced into near, if not outright, deflation to restore their lost competitiveness. …

The ECB was late to diagnose the issue and super-late to act. But the real issue is that neither its recent move nor any imagined future quantitative easing will do anything to reverse deflationary wage trends any time soon – trends established by deliberate policy.

Read Bibow’s letter here.

Here’s a piece I published in HuffPost back on Oct 18, 2010. A flash from the past – three years ago – predicting that QE2 would prove to be as impotent as QE1 had been. And here we are, folks. No recovery in sight–at least once you get off Wall Street.

We’re now set–yet again – to go off the fiscal cliff. Some have begun to talk again of the Trillion Dollar Coin – an idea President Obama has again rejected. He fears it would get tied up in the courts. So what? That would take years to settle.

Or perhaps he doesn’t want to break the logjam. Politically, he’s winning while the Republicans self-destruct.

However, here’s a better idea. We’ve got museums and national parks shut down. Why not sell them to the Fed? We can find a few trillion dollars of Federal Government assets to sell – and the Treasury can pay down enough debt to postpone hitting the debt limit for years. Heck, if we run out of Parks and Recreation facilities to sell, why not have the Fed start buying up National Defense? How much are our nukes worth? That should provide enough spending room to keep the Deficit Hawk Republicans and Democrats happy for a decade or two.

Have you ever been inside one of the Fed’s buildings? Nice, huh? Good place to display art and artifacts. There’s little doubt that the Fed knows how to put on a good show. (Note I was recently in Colombia and found that the central bank does own and run museums – and does an excellent job. When you’ve got the magic porridge pot, you can afford good housekeeping.) Imagine the Fed running the National Parks. Without budget constraints! Fine wine served at every campfire. Flushing toilets – not those smelly old pits. And hot showers. Mints left on pillows before you turn in for the night. Hot espresso with your wake-up call. Bullet train to the top of Half Dome.

And the Fed has pretty safe safes – good places to store the nukes. Call me crazy, but I think I’d feel a bit more comfortable with either Uncle Ben or Aunt Janet with fingers on the triggers than most of our past, present or future presidents.

OK, enough of that. Here’s my 2010 piece:

Why QE2 Won’t Save Our Sinking Ship continue reading…

Randall Wray on quantitative easing and the accumulation of reserves:

When the Fed buys assets, it purchases them by crediting banks with reserves. So the result of QE is that the Fed’s balance sheet grows rapidly—to, literally, trillions of dollars. At the same time, banks exchange the assets they are selling (the Treasuries and MBSs that the Fed is buying) for credits to their reserves held at the Fed. Normally, banks try to minimize reserve holdings—to what they need to cover payments clearing (banks clear accounts with one another using reserves) as well as Fed-imposed required reserve ratios. With QE, the banks have ended up with humongous quantities of excess reserves.

As we said, normally banks would not hold excess reserves voluntarily—reserves used to earn zero, so banks would try to lend them out in the fed funds market (to other banks). But in the ZIRP environment, they can’t get any return on lending reserves. Further, the Fed switched policy in the aftermath of the crisis so that it now pays a small, positive return on reserves. So the banks are holding the excess reserves and the Fed credits them with a bit of interest. They aren’t thrilled with that but there’s nothing they can do: the Fed offers them a price they cannot refuse on the Treasuries and MBSs it wants to buy, and they get stuck with the reserves.

A lot of people—including policy makers—exhort the banks to “lend out the reserves” on the notion that this would “get the economy going.” There are two problems with that. First, banks can lend reserves only to other banks—and all the other banks have exactly the same problem: too many reserves. A bank cannot lend reserves to your household or firm. You do not have an account at the Fed, so there is no operational maneuver that would allow you to borrow the reserves (when a bank lends reserves to another bank, the Fed debits the lending bank’s reserves and credits the borrowing bank’s reserves). Unless you are a bank, you cannot borrow them.

The second problem is that banks don’t need reserves in order to lend. What they need is good, willing, and credit-worthy borrowers. That is what is sadly lacking. Those who are credit-worthy are not willing; those who are willing are mostly not credit-worthy.

And we should be glad that banks are not currently lending to the [non-credit-worthy]. Here’s why: that’s what got us into this mess in the first place.

Read the rest here.

Kevin Drum has excised another section of the now-famous leaked fundraiser video, and this time the GOP challenger is holding forth on quantitative easing and other subjects. Drum picks on Romney’s specific claim that the government is buying three-quarters of US treasury debt, but there’s something in this quotation that’s more fundamentally off:

We’re living in this borrowed fantasy world, where the government keeps on borrowing money. You know, we borrow this extra trillion a year, we wonder who’s loaning us the trillion? The Chinese aren’t loaning us anymore. The Russians aren’t loaning it to us anymore. So who’s giving us the trillion? And the answer is we’re just making it up. The Federal Reserve is just taking it and saying, “Here, we’re giving it.” It’s just made up money, and this does not augur well for our economic future.

The problem here is that Romney’s “fantasy” world, in which the government “makes up” money, is just a roughly accurate description of fiat money.  And if you’re rooting around in the text of Obama’s American Recovery and Reinvestment Act for the dastardly provision that created this new “feeyat” money thing, don’t waste your time—it’s been around for a long, long time.  If you’re interested in the actual history of money, as opposed to the “we used to have real money before January 2009″ version, this working paper gives a nice rundown of the anthropological and historical material and lays out the economic policy upshot.

Whether it’s buying three-quarters of new treasury debt or a tiny fraction, the Fed is always using “made up money.”  And in theory (which is to say, aside from the various legal obstacles placed in its way), the Fed can buy as much US treasury debt as it wants, because it can never exhaust its ability to “make up” more money.  Don’t believe me?  Ask Alan Greenspan:

To the extent that there’s a real policy limit to this, it’s not that the Fed will somehow run out of money, but that at some point, when the economy is closer to running at full capacity, buying US debt to keep interest rates low could lead to inflation.  But inflation, for now and the near future, just isn’t a significant problem.  (On the contrary, the current challenge is to figure out how to get more of it.)

There are plenty of things to worry about in our current economic situation.  Unemployment would be pretty close to the top of the list.  Fiat money should not be.

Randall Wray joined Suzi Weissman for radio KPFK’s Beneath the Surface to discuss monetary policy, financial fraud, and a number of other issues.  The interview kicked off with Wray explaining his skepticism of the effectiveness of monetary policy, and in particular of quantitative easing, under current conditions, touching also on the question of why this long-term bias in favor of monetary over fiscal policy has developed.  The interview turned to LIBOR and the long string of recent financial scandals and outright fraud, with Wray tying it all to a broader (and growing) financialization of the economy.  Elaborating on the dominance of the FIRE sector in our economy, he discussed the increasingly fuzzy boundaries between, say, finance and industry.

Listen to the interview here.

While the latest figures show the unemployment rate dipping below 9 percent, a lot of this decrease has to do with individuals giving up and leaving the labor force.  As for additional stimulus, Congress is currently negotiating an extension, and possible expansion, of the payroll tax cut.  But Republicans are insisting that it be “paid for,” so it’s not yet clear what effect this would have if passed.  That leaves the Federal Reserve as the only US institution to turn to.  Zero Hedge tries to provide some (small) reason for optimism on this front, suggesting that the composition of the FOMC may become more “dovish” in 2012 when the next group of voting members is rotated in (Fisher, Kocherlakota, Evans, and Prosser out; Pianalto, Lacker, Lockhart, and Williams in).

by Jörg Bibow, Skidmore College

Developments surrounding the recent G-20 summit further underlined some starkly conflicting views among key global policymakers, an important “American-German divide” in matters of macroeconomic policy in particular. For instance, referring to the Federal Reserve’s latest quantitative easing (“QE2”) initiative, Germany’s finance minister Wolfgang Schäuble briskly attacked U.S. policy as “clueless” and “irresponsible”. In his view, it is inconsistent for the U.S. to accuse the Chinese of exchange rate manipulation while steering the “dollar exchange rate artificially lower with the help of their printing press”. While highlighting that the final remnants of global policy consensus at the G20 level have evaporated, Mr Schäuble is clearly missing the real inconsistencies in international policymaking today.

Take Mr Schäuble’s assertion that Germany’s export success was not based on any exchange rate tricks, but on increased competitiveness. This would seem to imply that the euro’s decline from $1.50 to $1.20 in the context of Europe’s so-called “sovereign debt crisis” was neither a competitive depreciation nor any other kind of exchange rate trick, but a legitimate booster of German competitiveness; conveniently super-charging Germany’s export engine though. Rather less convenient, at least from the viewpoint of the rest of the world, is the fact that austerity across Europe will do little to boost German and European imports – when Europe happens to be the U.S.’s most important export market.

continue reading…

With the recent announcement of QE2 (quantitative easing 2), the Federal Reserve’s new round of long-maturity asset purchases, it is worth looking at some of the effects of QE1. In November 2008, the Fed announced large-scale purchases of mortgage-backed securities and debt issued by the GSEs. Its securities holdings began to climb sharply in early 2009. As shown in blue, the monetary base (a broad measure of the Fed’s liabilities) had already begun to rise several months earlier. New asset purchases for QE1 ended earlier this year.

The effects of QE1 and the other stimulative policies adopted by the Fed since late 2008 will be debated for some time to come. But notably, the green line shows that a trade-weighted index of the dollar’s value against a basket of foreign currencies has declined quite a bit. Some world leaders are unhappy about this development, but it may have helped to spur real (inflation-adjusted) U.S. exports, shown in red.

The orange line shows the yield on a 10-year inflation-indexed Treasury security, which can be used as a measure of the real interest rate. This rate has tumbled from well over 3.5 percent to negative levels. Some economists doubt that a monetary authority such as the Fed can succeed in reducing real long-term interest rates over a prolonged period, but this is a remarkably sustained trend.

Notes: The interest rate series in the graph has been rescaled (actually, multiplied by 100), so that its movements can be seen more easily. The export series has been deflated to 2005 dollars, using a chain-weighted GDP price index. The exchange-rate series, which is the Fed’s index of the value of the dollar against the “major currencies,” is scaled so that the first observation equals 1000. The monetary base is expressed in billions of dollars. Except for the exchange rate and interest rate series, all data shown in the figure have been seasonally adjusted. Detailed information on the Fed’s asset purchases and its balance sheet can be found in this series of official reports.

After its last meeting, the Federal Open Market Committee, which makes decisions about Federal Reserve monetary policy, decided to keep its holdings of long-term securities constant. The Fed was forced to look again at this issue because borrowers have been paying off the long-term debt securities already in its portfolio. This maturing debt consists mostly of Treasury bonds, mortgage-backed securities, and Fannie Mae and Freddie Mac bonds, most of which were acquired quite recently. The Fed will reinvest the repayments in more long-term Treasury bonds instead of allowing its balance sheet to shrink.

Some have referred to the Fed’s acquisition of certain assets not normally seen on its balance sheet by the special term “quantitative easing,” or QE. This term is perhaps somewhat misleading, because it implies a sharp distinction between the recent policies to which it refers and the Fed’s more typical manipulations of the federal funds and discount rates. But, surprise, the new policy actions also involve interest rates, albeit ones that the Fed had not attempted to directly influence in many years when it began QE in 2008. Let’s hear what Ben Bernanke said at a conference last week:

….changes in the net supply of an asset available to investors affect its yield and those of broadly similar assets. Thus, our purchases of Treasury, agency debt, and agency MBS [mortgage-backed securities] likely both reduced the yields on those securities and also pushed investors into holding other assets with similar characteristics, such as credit risk and duration. For example, some investors who sold MBS to the Fed may have replaced them in their portfolios with longer-term, high-quality corporate bonds, depressing the yields on those assets as well.

In other words, the Fed is buying long-term securities mainly as a means of reducing the interest rates paid by the federal government and other borrowers when they issue long-term debt. These rates are crucial because many large purchases are paid for over a long period of time. These include homes and large-scale corporate investments such as new factories, which are usually expected to yield revenues over a stretch of many years. Of course, the Fed has not set an explicit target for any long-term interest rates. But it certainly did that during and immediately after World War II, which was the last time the federal debt was so large as a percentage of GDP. (Interestingly, during its history, the Fed has not always publicly committed itself to any interest-rate target at all.)

This graph, which shows interest rates on long-term securities issued by the federal government, offers some historical perspective on just how low interest rates are:

The figure depicts two data series maintained by the Federal Reserve, which I have had to splice together because neither series covers the entire time period shown in the graph, January 1925 to July 2010. It shows that throughout World War II and until 1953, the Fed kept long-term interest rates below 3 percent, which helped keep the cost of federal debt low. Of course, to do this, the Fed had to purchase many long-term government bonds. We wonder what will happen next.

(Graph updated with August 2010 data point and resized for readability September 15, 2010.)