The US Fed has decided to start unwinding QE. Barbara Yellen has said the process will be as exciting as watching paint dry. And who knows? Maybe she is right. After all, there is no precedent. It’s obviously possible that this could go well. But I doubt it.
So, we’ve moved from something that could not, never would, happen, to something that could obviously go well. Not sure who Barbara is but still.
The reasons should not need stating, I would have thought, but it seems that they do. This is not, after all, a microeconomic issue about the Fed reducing the size of its balance sheet, which is how most commentators seem to be decribing it. This is, instead, a macroeconomic issue about money supply, interest rates and desired rates of growth.
Well, yes, as all have been saying all along, this is a macro issue about the money supply.
From the way reports are being written it would seem as if the Fed creating money is a sin: a large Fed balance sheet is a weakness in the descriptions offered. Whether Yellen actually thinks that or not I am not sure.
No, the general description – among economists of course, those Snippa never reads – is that QE was a just great idea but it has a limited life as a great idea.
I make the comparison deliberately. It so happens that we should want commercial banks to cut the size of their balance sheets. We have a debt crisis, after all. Debt is what fuels the size of their balance sheets. And the evidence is very clear. Those balance sheets are too big. The consequence is the risk of another crash.
No one else is aware that we want the banking system to shrink its balance sheet. We are indeed annoyed at the too big to fail banks but that’s another matter. The sector as a whole we’re fine about. And, erm, rather the point of monetary policy this past decade has been to try and get the banking system to expand its balance sheet. You know, lend more to people who are going to undertake economic activity with it?
But as we also know, private sector debt reduction is the equivalent of saving. And if there is saving there are consequences. First, there is less money to go round. It was, after all, a crisis of too much saving (or debt reduction) post 20o8 that required QE in the first place. Second, less money going round means slower growth. Third, it also means that someone has to match the saving with a borrowing. That’s what the sectoral balance dictates. And as the government is the borrower of last report they pick up the tab.
So, err, selling those bonds back into the private sector expands that private sector balance sheet, doesn’t it?
Now let’s look at the US (and think about the UK). The US has some (but I would call it shaky) growth, low interest rates, modest inflation and some pretty big uncertainties, all underpinned by far too much private debt because the middle class has been hollowed out. It’s not a pretty prospect. And in the middle of all this Yellen wants to suck money out of the economy by selling part of the Fed portfolio (which is much broader in base than the Bank of England’s) back into the market even though the government is still running a pretty massive deficit and personal debt is too high.
Yes, because we think that a massively expanded M0 will increase inflation as V returns to something lose to normal. The entire point of this is to pull M0 out of the economy. But leave M4 roughly unchanged, as we do think that V is rising. Seriously, this is really very basic money supply stuff even if it is beyond the Senior Lecturer.
I have to say I can only see three potential consequences of that. The first is a drain on the economy and a reversal of the modest growth.
Why? Growth – and inflation – are dependent upon M4, not M0.
The second is a pretty big increase in interest rates to get people to buy this stuff that they don’t prima facie need right now, with a consequent pretty big drain on the real economy and the unveiling of just what debt stress really means in the US context, with a pretty hard hit in the economy for a multitude of reasons as a result.
Personally I expect the change in interest rates to be measured in tens of basis points at most.
But even if this last was true this would be worrying. There is a debt crisis in the US, in private banks (as here). And there is a crisis of government underspending on what is needed, like infrastructure, as here (except their bridges really do look like they are falling down in the parts I visit). And instead of managing a shrinkage of the balance sheets of private banks, matched by an increase in the size of the Federal (not Fed, unless a form of People’s QE was used) balance sheet it is the Fed that is to be shrunk . There’s one real reasonable reaction to that. This is the wrong policy at the wrong time and for the wrong reason. The wrong outcome will result.
There will be tears. But Yellen will have gone by then.
What’re those stages of grief? He seems to be just about moving past denial right now…..