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Quantitative Unease

Sunday, November 14, 2010, 15:55 EST Leave a comment Go to comments

Money printerEven though no one has ever accused me of being an economist, I like to think I have a basic understanding of economic principles, having studied basic micro- and macro-economics in the process of earning a business degree 20+ years ago. I’m also reasonably intelligent. So when my efforts to learn a bit about something in the news recently called quantitative easing left me more confused than when I started, I grew uncomfortable.

Try wrapping your mind around this, via Reason.com:

Once the members of the Federal Open Market Committee vote to buy additional bonds, the Fed schedules a series of sales, and notifies the banks on its list of primary dealers—18 very large banks. Those banks then buy up bonds with the intention of selling them at higher rates to the Fed. And then when the scheduled sales come around, they trade their store of bonds for money that the Fed has newly created, as The Washington Post explained, “essentially out of thin air.” Interest rates go down. Inflation goes up. Investors, knowing that money is cheap now and might not be worth as much later, start to spend. The economy gets back in gear.

Pardon me if I get nervous hearing about “newly created” money, which evokes images of basement counterfeiters. How is money printed by the Treasury without the backing of assets any different from high quality copies of currency created by an enterprising criminal with a high-quality color printer? Then there is the issue of interest rates going down. Practically speaking, aren’t they already as low as they can be?

Perhaps I’m just dense. Let’s assume for a moment that I am simply not sophisticated enough to understand concepts like the consequences of monetary policy. I’m sure the experts know much more than I do. Again, from the first article:

It’s not the first time the Fed has pursued the QE strategy (hence QE2), and the first go-round wasn’t an obvious success. When the financial crisis first landed, the Fed pumped $1.7 trillion into the system, yet failed to lift the economy out of its sluggish state.

That’s how you know these are government economists. “What we did didn’t work; we have to do more of it!” Maybe I’m onto something, thinking this makes no sense.

By now, I’m thinking that I need another explanation to help me understand why this is a good idea. How about this piece from NPR:

[Quantitative easing] means creating massive amounts of money out of thin air with the hope of getting the economy back on track.

[ . . . ]

A big bank — Bank of America, say — has $50 billion in government bonds. They’d sell those bonds if anyone would pay enough for them, but nobody is willing to pay that much. So the bank just holds on to them.

With quantitative easing, the Fed comes along and says, “Hey, Bank of America, we’ll buy those bonds for a little more than anyone else is willing to pay.” Bank of America says, “OK, great, send us the money.”

This is where the Fed gets to use central-bank magic. They pay for that $50 billion purchase in new money. They just invent it. That’s what the Fed — but nobody else — gets to do.

So now Bank of America has $50 billion they need to do something with. The Fed is hoping that Bank of America will decide to lend that $50 billion to companies and people to invest or spend. That stimulates the whole economy.

Wait a minute, didn’t we try that in the form of bank bailouts? Aren’t we just grasping at straws thinking that doing the same thing but calling it something different will somehow work out better? Is that a plan, or just wishful thinking? The answer comes at the end:

While the economy is still this bad, the Fed really might only have two options: Do this as a desperation move, or do nothing.

Maybe doing nothing wouldn’t be such a bad thing. Increasing the money supply won’t ease consumers’ concern about the future, and as I’ve often been told, it’s uncertainty that makes people less willing to spend. People are already anxious about the effect of ObamaCare (the insurer mandates of which have already driven some premiums up), they don’t know what’s going to happen to federal income taxes once the President and the new Republican majority in the House finish their bickering, and they live with daily reminders that the federal government’s previous attempts to stimulate the economy have been an abject failure. Now the Fed is talking about embarking on a gargantuan experiment whose effect is anyone’s guess. Yeah, that’s the way to instill confidence in the economy.

Come to think of it, I don’t think I’m the one with a comprehension problem. I think the so-called experts have a common sense problem. Confidence in the machinery of government is at an all-time low, so keeping it (in whatever form it takes, be it the Presidency, the Congress, or the Federal Reserve) out of the equation might do more to fix what’s broken than anything else. Sometimes, doing nothing is the best action of all.

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