US Fed QE2

[MichaelB]

The Fed’s possible new program of quantitative easing, called QE2, is designed to counter deflationary pressures, reflate asset prices, and reestablish inflation to so that it averages 2.5% over the next 5 years. It intends to accomplish this by buying 100's of billions of financial assets. Will the Fed achieve its goals?

 

[FIREd]

I have no clue. Some economists say that QE2 would have to be in the $4-6 trillion range to be effective. Some put that number even higher. Based on that, it seems like a few hundred billions in asset purchase would be quite inadequate to move the needle.

 

[haha]

Hussman has a good article about this topic today. He thinks that with enough activity the Fed can both lower short and long term interest rates, and cause at least temporary asset price expansion. Regarding stocks, he feels that they will respond, but will also become more and more prone to abrupt downmoves similar to 2008.

It seems to me that little B is actually trying to revive the same conditions that caused our recent difficulty.

One thing I don't see being discussed- negative real interest rates jack up commodity prices. High oil prices are deflationary to real economic activity. Thus raising asset prices may actually push us into another recession.

I think history will view Bernanke as a terrible mistake.

Ha

 

[ziggy29]

Biflation will rage on. And possibly become even more severe.

 

[MasterBlaster]

Biflation will rage on. And possibly become even more severe.

Is that some expensive sex thing ?

 

[ziggy29]

Is that some expensive sex thing ?

http://www.early-retirement.org/forums/f28/biflation-51850.html

 

[harley]

I'm sure this is simplistic, but I voted option A because I don't think you can spend your way out of debt, long term. But then I'm not a Nobel winning [-]columnist[/-] economist.

 

[Gone4Good]

Even the proponents of quantitative easing are pretty pessimistic about both its effectiveness and the Fed's willingness to pursue it on a scale large enough to have an impact. So in all likelihood, were looking at a small program without major benefit.

 

[kyounge1956]

I voted "no clue" but I'm not sure about the difference between "fall back into a recession" and "fall back into deflation". Which one fell further?

And speaking of "fall back", do we go off Daylight Savings Time next weekend?

 

[MichaelB]

I voted "no clue" but I'm not sure about the difference between "fall back into a recession" and "fall back into deflation". Which one fell further?

And speaking of "fall back", do we go off Daylight Savings Time next weekend?

Slight deflation (option 2) is bad. Recession (option 1) is much worse.

Not so many answers and most choose “not sure” This an educated and focused group, so if folks here are unsure, a larger percentage of the general public would be uncertain. This is not good. Economics is behavioral – people need to feel certainty or they will not act.

I understand how QE2 can lift prices of financial assets, like bonds, and also how it keeps the yield curve sharp but low overall. That means banks and financial institutions can be profitable, and that should help stock prices – and push commodity prices up. What I don’t see is how this translates into general demand or jobs.

Perhaps the Fed is just trying to raise prices and will keep them there until job growth starts again on its own. I don’t think this will work. This whole thing is FUBAR.

 

[Gone4Good]

What I don’t see is how this translates into general demand or jobs.

In theory, it does that by making it painful to horde cash.

In a deflationary environment, holding cash is rewarding. Cash grows in real terms, risk free, at the rate of deflation. Meanwhile, risky business investment becomes even harder to justify in a declining price environment . . . why buy inventory, or build a factory, when it's value constantly depreciates? Similarly, why hire a worker at a downwardly inflexible wage to produce widgets whose price continually declines?

That process gets upended when people expect or experience inflation. Hording cash becomes painful, while consumption is rewarded and risky investment becomes a better alternative to the negative real rates earned on cash.

Not so many answers and most choose “not sure” This an educated and focused group, so if folks here are unsure, a larger percentage of the general public would be uncertain.

I may be giving us too much credit, but "not sure" seems like the most reasonable answer when questioning how something that has rarely been tried before will work.

 

[samclem]

Economics is behavioral – people need to feel certainty or they will not act.

Maybe there's be less certainty if the Fed indicated they were done with trying to force growth, and that they were concentrating on the stability of the US dollar. There's some value to having businesses concentrate on business and finance rather than waiting for the next hoped-for announcement of government gifts.

Like folks in a casino, business leaders don't expect certainty, but they'd appreciate it if the rules aren't changed by the house (or the senate, or the Fed).

 

[Emeritus]

Biflation will rage on. And possibly become even more severe.

The definition of "biflation" seems very silly. in any contraction the demand for some goods contracts faster than others, and substitution effects may enhance demand for "inferior" goods. If you can contract supply faster than demand contracts you can keep prices up despite declining volume cf airfares.

 

[FIREd]

This is not good. Economics is behavioral – people need to feel certainty or they will not act.

The biggest uncertainty I have right now is fiscal uncertainty. My investing/spending is on pause until I know what's going on on that front.

 

[Gone4Good]

The definition of "biflation" seems very silly.

My guess is that its an invention of the classical school folks who predicted hyper-inflation in [-]2008[/-], [-]2009[/-], [-]2010[/-], 2011 to explain why the inflation they predicted hasn't shown up in the official statistics. Unfortunately, biflation isn't really showing up in the official statistics either.

 

[haha]

Slight deflation (option 2) is bad.

I think it may depend on what is causing the deflation, the debt status of the economy, etc. Arguably the best, most prosperous, most peaceful time in modern history was the Pax Britannica of Queen Victoria's reign. There was an overall slow deflation during the entire long period. I believe that similar conditions continued until WW1 broke out.

Ha

 

[MichaelB]

In theory, it does that by making it painful to horde cash.

In a deflationary environment, holding cash is rewarding. Cash grows in real terms, risk free, at the rate of deflation. Meanwhile, risky business investment becomes even harder to justify in a declining price environment . . . why buy inventory, or build a factory, when it's value constantly depreciates? Similarly, why hire a worker at a downwardly inflexible wage to produce widgets whose price continually declines?

That process gets upended when people expect or experience inflation. Hording cash becomes painful, while consumption is rewarded and risky investment becomes a better alternative to the negative real rates earned on cash.



I may be giving us too much credit, but "not sure" seems like the most reasonable answer when questioning how something that has rarely been tried before will work.

That process gets upended when people expect or experience inflation. Hording cash becomes painful, while consumption is rewarded and risky investment becomes a better alternative to the negative real rates earned on cash.

Right. But how does than generate 6 million jobs or so.

That worked with the Fed under Mr. Greenspan – lowering the Fed rates and flooding the country with easy money stimulated the housing market, which led to lots of building, which employed lots of people. But that ended badly.

There is no possibility of a sustained economic recovery without substantial job growth. Is it 1) flood the world with $$ 2) let the US$ lose value 3) make US labor more competitive in the world market 4) this motivates business to produce more goods in the US both for local consumption and for export ?

 

[jimnjana]

I voted that I thought inflation would be greater than 3%. One thing for sure is that if they are successful in reducing the value of a dollar by 10%, the price of oil is going higher, probably by 10%. IMO, too many academics in the fed, and apparently now they are paying too much attention to politics. I think this will do more damage too the dollar than they realize. I guess people on social security will be happy they, will definitely be getting a "raise".

 

[MichaelB]

I think it may depend on what is causing the deflation, the debt status of the economy, etc. Arguably the best, most prosperous, most peaceful time in modern history was the Pax Britannica of Queen Victoria's reign. There was an overall slow deflation during the entire long period. I believe that similar conditions continued until WW1 broke out.

Ha

Let’s say chronic deflation resulting from weak demand, due to no real per capita economic growth combined with low labor utilization and impaired household and public balance sheets.

 

[Gone4Good]

Right. But how does than generate 6 million jobs or so.

Because instead of losing real purchasing power holding cash in an inflationary environment, I'm going to invest or spend that money. Or now that I expect my business will have pricing power, I can hire that worker without fear that my unit revenues (prices) will continue to decline even as my unit costs (wages) remain stable.

A new bubble isn't a prerequisite for any of this to happen.

 

[MichaelB]

Because instead of losing real purchasing power holding cash in an inflationary environment, I'm going to invest or spend that money. Or now that I expect my business will have pricing power, I can hire that worker without fear that my unit revenues (prices) will continue to decline even as my unit costs (wages) remain stable.

A new bubble isn't a prerequisite for any of this to happen.

Yes, but you hire that worker because you are going to produce more, not just sell at a higher price. You produce more because you can sell it - which means demand is growing. Could be external demand from a falling US$, could be increased demand from currently employed people that have saved enough and feel more confident about the future. But it's not demand from currently unemployed folks. Possible, I guess.

One of the reasons economists are always so gloomy is they are data driven, and a change in economic trend is partly behavioral, which they only see in the data after the fact. With uncertainty so high, I don't think people are going to loosen up the purse strings. Just the opposite.

 

[Gone4Good]

Yes, but you hire that worker because you are going to produce more, not just sell at a higher price. You produce more because you can sell it - which means demand is growing.

Agreed. But, in an extreme example, if inflation were 50%, and you had a dollar, would you hold on to that dollar for the next year and lose 50% of your purchasing power, or would you spend it immediately when it buys twice as much?

Inflation encourages people to spend cash and deflation encourages them to hold on to it.

 

[haha]

Agreed. But, in an extreme example, if inflation were 50%, and you had a dollar, would you hold on to that dollar for the next year and lose 50% of your purchasing power, or would you spend it immediately when it buys twice as much?

Inflation encourages people to spend cash and deflation encourages them to hold on to it.

This has been Bernanke's stated rationale all along. It makes theoretical sense, but it seems that under very high debt and poor employment conditions, it is hard to get that inflaion started, except in commodities and other assets. And commodity hoarding does very little for unemployment, or US GDP. In fact, these bubbles that get blown tend to depress demand by increasing risk and uncertainty. In particular, look out below for GDP and employment if crude and gasoline prices start climbing due to Li'l B's machinations.

Milton Friedman was correct- we would be better off to disband the FRB and replace both its liquidity function and its credit/monetary growth function by a set of algorithms giving a highly damped output.

Ha

 

[ziggy29]

Agreed. But, in an extreme example, if inflation were 50%, and you had a dollar, would you hold on to that dollar for the next year and lose 50% of your purchasing power, or would you spend it immediately when it buys twice as much?

Even stoking inflation may not kick-start spending, though. Cash hoarding isn't only happening because of deflation; in fact, I'd say that's at best the *secondary* driver for hoarding cash.

The main driver? People feeling like they are going to need a practically Armageddon-proof pile of cash to survive a terrible employment market which could last for who knows how many years. Even many who have kept their employment through the whole mess feel like they could be next. So they hoard cash to help them survive it.

Easier said than done, I understand, but get people back to work -- steady work they don't feel they could lose next week or next month or next year -- and deflation is more likely to go away than by waging a War on Savers with monetary policy.

 

[Gone4Good]

Even stoking inflation may not kick-start spending, though.

Which is why even proponents of QE2 aren't terribly optimistic about it and why many view it as a second best alternative to . . . fiscal stimulus (queue shrieks of horror).