The Money View


Last Thursday, the Fed announced its anticipated third round of balance-sheet expansion, at a fixed rate of about $40B per month "until [substantial] improvement [in unemployment] is achieved in a context of price stability". A relief, perhaps, to see some attempt at boosting the economy. But in a column that appears to praise Bernanke for doing something—anything—Martin Wolf still suspects the policy will fail to live up to hopes, and I am inclined to agree.

How should we understand QE3? The Fed promises to buy MBS, and possibly other assets, at a fixed and steady pace until employment improves. The immediate effect is to absorb such assets from elsewhere in the financial system. This is, in the first instance, a boost to the liquidity of these securities: when a big-time buyer is out there, it will be easier to sell, and knowing that a big-time buyer will continue to be out there, others will be more likely to buy.

Large-scale purchases (and $40B a month is quite large-scale) can also be expected to raise the price of the securities, and anticipation of such effects went immediately to the benefit of bank share prices, which spiked after the policy was announced.

The existing supply is unlikely to be enough to meet the Fed's demand for too long, and so it will have to be met with new origination of the underlying mortgage loans. The Fed's statement says it aims to "put downward pressure on longer-term interest rates." What channel would make this work? The Fed could be hoping that its presence as a buyer will support new lending. If this new lending facilitates an increase in sales of new homes, equity withdrawals (or refinancing) to finance consumer demand, it could increase aggregate demand and GDP.

In balance sheets, the channel looks like this:

But this is quite an indirect way to generate demand. Narrowly, a spread already seems to be opening between rates faced by borrowers and MBS yields—the origination channel, so to speak, can not be counted on to transmit the asset purchases all the way to households. The yield on MBS rises, but rather than mortgage rates falling, originators are capturing a wider spread between the two rates. The rise in MBS prices, that is, leaks out as increased fees to the financial sector.

At the highest level, finally, does QE3 get at what is keeping aggregate demand down? If the problem remains, still, overindebted households unwilling to increase their demand for newly produced goods and services, then this liquidity-providing operation will have very little effect. If there is too much debt out there, and it is to be reduced, someone will have to write that debt down against equity. This is not a feature of QE3 as announced.

Special video feature

This final observation on QE3 offers a passable segue to the ECB's announcement of outright monetary transactions earlier this month, and George Soros's plan to address eurozone sovereign indebtedness. After a conversation this morning, I decided to take the US, in words, and Perry took Europe, in a video:




Hm...forgive me if I am misunderstanding....but won't the effect be that people will have an easier time refinancing? This, indirectly, I think would help reduce household debt level and improve spending just a little bit?


I do mention refinancing in the paragraph above the T accounts. Refinancing at a lower interest rate could support spending, but with rates already at 3.5%, how much more spending can be freed up this way?

And note that refinancing does nothing to change the household debt level. For that, you would need debt forgiveness, or default.


Is debt forgiveness or default the only two ways?

Can not inflation be used to reduce the debt?
Alternatively, make the huge debt bearable by securing very low interest rates for very long time?


It might help household debt level a bit, in that a better rate might help it get paid down faster, I think. On the whole though, it's not really going to do much other than boost stocks as usual.

Richard Duncan's book "The New Depression" says that central authorities are now locked in to periodic printing because they have to maintain total credit levels, or face a reversal of the last 40 years. It doesn't solve any problems, but it helps delay the day of reckoning, apparently.


there is nothing to make the banks pass on the reduced interst rates to the public or refinance. What the banks were doing before were making increased profits by the yeild spread. they aren't nad haven't been passing the monetary policy to the public. the transmission mechanism is broken and the berbabke policy does not address this. But as detailed over and over on this site they use models where banks don't exist and monetary policy is in essence transmitted without friction. Now, I have a very dim view of Mr. Bernanke and think he realizes what I am writing is true, so one must ask where his real motices are with this policy. I in no believe they are his stated goals.


Asgeir, you are quite right that inflation would also reduce the debt burden. Some would call inflation a kind of default, since the real value of the repayment is less than anticipated.

Low interest rates can make debt more bearable, but in the case of US mortgages, most borrowers who are able have already refinanced into low fixed interest rates. So lowering the rate further is not going to have much more impact.


But how do you get inflation in this credit economy without getting new credit into circulation?


If the FED (or ECB) was allowed to purchase as many government securities, MBS and private bonds as it desires in order to supply the economy with money at a constant annual rate, even in those times when, otherwise, the private banks would go through a ‘credit crunch’ phase, then (1)the FED/ECB would gain credits from the bond holders against the debtors (including the governments). (2)The FED/ECB would pay back the money to the bond-holders instead of the indebted states, so the investors could recover their money. (3)This action could give liquidity to the bond-holder banks in times when liquidity is scarce. It would be a blessing to the economy, and (4)the FED/ECB could continue to put pressure on the debtors (managing the ‘moral hazard’)-without risking the operation of the money intermediary system as a whole. So QE3 is good, but not enough. The economy needs more: fiscal stimulus. The main Neoclassical criticism against Keynes’ recommendations was that they don’t boost the economy if the money that is pumped into a given country flows beyond its borders. This may be true, but we literally have to broaden our horizon and adopt an international perspective rather than bury Keynes’ theory out of short-sightedness. If we do so, we will see that the more was spent in the United States, the more jobs were generated in the emerging region, e.g in China. Furthermore, because cheap Chinese products replaced more expensive ones, U.S. economists did not even experience significant (wage-price) inflation. To achieve all this, China had to regard the dollar as substance. China owes its success to consumption in the U.S.A and the rest of the Western world. The EU and the US had better (1)ease their fiscal and monetary policy, (2)and focus on environmentally friendly developments and sociological programmes as the new fields of prosperity,(3)rather than menacing their own people with impossible target indicators, like the ‘sound state budget’.


From a global perspective, the best-case is this: QE3, via the wealth effect, could sustain the current mediocre growth rate of the US economy, buying the US just about enough time to postpone fiscal consolidation until late 2013 or 2014, by which time the Eurozone and UK could be finished with bulk of their fiscal adjustment, and return to growth. Another element that needs to fall into place is the continued growth of China and the emerging economies. The US could then rely on foreign demand. That's about it: QE3 buys time, with some help at the margin (a bit more household de-leveraging, a bit of a wealth effect), and hope for the best.



"From a global perspective" - what is a global perspective?
"The best case" - what is best and why is it best?
"The wealth effect" - how is QE3 connected to a perception of wealth, across the board? (It is clear that financial companies who are beneficiaries of commission and trade volume enjoy a brief wealth effect, but what about the rest?)
"The current mediocre growth rate" - this is directly connected to credit growth and therefore QE3, and has nothing to do with wealth effects
"Fiscal consolidation" - the US does not need to engage in fiscal consolidation at all, because it can spend into its own economy at will and without risk of domestic inflation.
"Eurozone and UK could be finished with their fiscal adjustment" - which will never happen because the main problem there is lack of government spending, needed to avoid debt-deflation and collapse
"the continued growth of China" - which does not equate to continued asset price inflation in China, and can only occur through increase in domestic consumption and development of domestic/regional economy, and a decoupling from USD
"That's about it: QE3 buys time" - absolutely right.


@Frank: thanks for following the thread and taking the time to respond to comments. I try to keep the level of conversation here elevated, and I'm not sure a point-by-point confrontation to another comment achieves that. So I ask that you try to articulate clearly your point of view and your objections to Mikio's comment.

Thanks again for reading.


inflation onlyy lowers the debt burden if growth in wages rises faster than price rises. if wages rise slowly, then the inflation reduces discretionary expenditures reducing aggregate demand. hence hurting the economy. This may not be the case when the rise in prices are fast enough that people won't save for fear the price will rise. the actual behavior of people in this situation isn't what economists predict, and in fact is a rather typical assumption of really really bad economics thinking. When people feel they have to pay down debt, and prices rise, in the setting of economic uncertainty and even if working, they will in fact spend less because they fear the future prices and don't feel they can spend now.

If one actually looks at japan and does a real analysis of the data, it is only via deflation that the japanese have been able to maintain a lifestyle. The real reason why we have inflation targeting, has nothing to do with economics, it has to do with the financial sysstem. an over leveraged system can't have deflation at all. Prices drop, margin calls, the over leveraged are shown to be broke. The banks proven insolvent. Inflation targeting allows for the system to assume prices will in essence rise over time and therefore encourages over leveraging in the system. In this way it in fact promotes instability and "ponzi" finance as described by Minsky. In fact is is very impt to have periodic episodes of deflation in order that the market forces economic discipline on speculators and they can go under. When continued for long periods the over leveraging becumes greater and places the entire system at risk. The bernanke policy is all about one thing in reality, making sure the banks aren't shown to be insolvent promoting and rewarding speculators, making sure the financial system doesn't delever. It has nothing at all to do with any public statement the man has made.
I realize to make the claim the man is a liar is rather harsh, but I'd be happy to pay for the polygraph and write a public apology if I am wrong. Plus I'd be willing to put 10 grand into his charity of choice. I'm not wrong


the bank of england did a study showing the effect of qe was to increase wealth inequaltiy. increasing the top 10% the most because they own the most financial assets. I honestly believe the term has been made up to justify policy, or it is that those who make the policy are mainly surrounded by the top 10% and they experience a wealth effect. I do not beleive it really exists in any substantial form. Plus, if the wealth effect if by credit, it must in the future lead to decreased consumption as that credit is paid off. As we are seeing from all of the credit taken out against homes. Inflation does not increase aggregate consumption in the setting of wage increases below the price of inflation. meaning inflation for inflations sake does not stimulate the economy. Inflation when driven by demand and wage pressures dos not hurt. making assumptions that the two kinds of inflation are the same, as it seems most central bankers do, is a false logic


I will not be approving additional comments to this post as we have gotten quite far from the intent of the original post, and the comments I see in the queue are not an improvement in that regard. Thanks all for reading.



Your concluding comment implies that you may not publish my comment; this would be alright with me. I have a suggestion. If you can produce a concise summary based on your initiating post and the ensuing discussions, which would give pointers to the sparks of new economic thinking in the thread, it would be very interesting, I think.

Best regards,


Exactly. The ZLB implies closing costs will shut down refinancing.

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