Who owns whom? (QE edition)

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When thinking about policy, I always try and start with ‘Classical thinking’ and then identify the frictions that take us away from that solution.

The key problem with the portfolio balance argument the Fed (and other central banks) have used to justify the efficacy of balance sheet policies is that the taxpayer owns the central bank, so we are just shifting the risk around rather than reducing net private sector risk.

As with all ‘Ricardian equivalence’ type theories, I am ambivalent on this one. Just as I doubt that folks know much about the tax-debt mix, I suspect they know little of the risks that have been assumed by their central bank (a previously cautious money issuer that’s now operating like a hedge fund).

The reason these theories are useful is that the equilibriums they describe appear to act as attractors. In the longer run, agents may figure it out for ordinary folks … tax agents help us manage our future tax liabilites, and financial managers help us manage the risks to our wealth.

This brings me to an interesting FT op-ed by Blackrock’s Peter Fisher.

Peter headed the SOMA portfolio at the FRBNY, and did a stint at the US Treasury, so he (of all people) understands what’s going on … and rather than being squeezed into taking risk by QE (the ‘portfolio balance’ effect) he’s being pushed away from it (the ‘Ricardian balance’ effect):

it is time to face the simple truth that, as they approach zero, lower interest rates will not automatically create more credit and more economic activity but, rather, run the significant risk of perversely discouraging the lending and investment that we need


  1. It seems like Fisher is saying much the same as Woodford in his latest paper from the quote you’ve provided above. Keeping rates close to zero for extended period can perversely result in agents believing that monetary policy will either be effectively tight or increasingly tight if that isn’t accompanied by the central bank’s intentions with regards to zero rates.

    Woodford’s conclusion is that zero rates should be accompanied by intention of central bank to level target NGDP. I.e “rates will stay at zero until we hit the level we were expecting before we had this drop”.

    1. This is also in Woodford’s paper, but a different part – basically he says we own the Fed so the portfolio balance idea (private sector loses risky assets and seeks to replace them) doesn’t make sense as the private sector retains the risk via their share in the central bank.

      1. As a monopoly currency issuer, the central bank has zero financial risk – and therefore taxpayer has zero financial risk. So I am have real troble with your arguments here.

        Let me put it to you this way. If you lived in a Country which only used “Ricardo Dollars” and only you were the sole issuer of those dollars, would you be concerned at making a financial loss?

    2. As for NGDP level targets, i read that as a commitment device – a way to promise not to revert to inflation targeting when inflation picks up.

      1. Agree with both points.

        Haven’t quite gotten up to the equivalence idea in your first comment. But I saw it in the summaries.

        As to the NGDP level target: Woodford seems to distinguish between “intentions” and “committment”. Intention more or less tells agents how the central bank will act in various states of the world (its rule if you like). A commitment may or may not provide this signalling (e.g. the Canadian central bank did vs the Swedes) especially when the stated rule is that of inflation targeting.

  2. Yes, I agree… the cost of money has been lowered like never before… but the main problem remains: not enough people want that money anyway.
    If you think of money like a product that you can sell and buy at a shop… there’s a period where everybody it wants it, even demands it. And you can set your price higher. The higher the price the more people want it, because it must be very good. If it’s that expensive it must be good and I should not miss out.
    But then the product goes out of fashion, so you need to lower the cost, but the more you lower the cost, the more people do not want your product… until you give it away for free… which means it must be total rubbish….
    …and that’s where we are. Need to think how to make the money product attractive rather than think about lowering its cost.

    This is a great book about “fair value”:
    Priceless: The Myth of Fair Value

    1. Indeed, that is one of the most useful ways of thinking about money – it is the ‘good’ on one side of every transaction.

    2. Thats a great point.

      Clearly consumers are not interested in taking on more debt and corporations are not seeing strong enough demand to force their hand on the investment side of things. Therefore the interest rate doesn’t really matter!

      As a result the current low policy rate is probably doing more long-term harm than good. The only thing that will heal this is time

      1. No – the healing can come from fiscal stimulus. Countries like the USA issue their own currency, therefore the spending never has to be “Paid back”. The idea past deficits have to be repaid is a myth as evidenced by the USA’s 220 year existence.

        Once one accepts currency issuers are never financial constrained, it follows the “Ricardian Equivalence” argument is clearly false.

        The only constraint to spending for a currency issuer is availability of real resources. And when unemployment is high, real resources are widely available.

        1. Unless you think inflation can increase real production over some long run, at some point all that money creates inflation (assuming mean reverting demand for cash) – which means that soured financial risk is ultimately paid for via inflation.

          I do not think that we can increase real production in the long run via inflation, but i do think that money gives the holder a nominal claim over output – so if the real output does not change much, but the nominal value of claims does, we have the classical inflation story of more money chasing goods.

          Now we can argue about how long the short run is … :)

      2. OK, explain about how Zimbabwe could not and can’t lower the unemployment rate then or even provide basic food for all of its citizens.
        They issue their own money, no? They have a lot of real resources available no? And they do not have to pay back any spending.
        How could Zimbabwe not become the richest country in the world, when they could print as much as they wanted??? Money grows on trees!

      3. I do not think Inflation can increase real production over any time frame. I think I was very clear on that point – but is was a nice strawman. The fact of the matter is you can increase money supply with a corresponsing increase in output in a non inflationary manner (MV = PQ). I think this is a pretty straight forward idea.

        When you have an output gap (measured by, say, cyclical unemployment), it is not hard to imagine an improvement in real output via stimulus simply via lower unemployment. Or you suggesting the current cycle is a reflection of Say’s Law and all unemployment is structrual?

        1. I like equations.

          So fix P (and bound V), and for sure greater M leads to greater Y.

          Now are all agree on the math – what we are debating are the time horizons over which this is true (for assuming mean reverting V, and no money illusion, eventually all increases in M go to P) and the short run elasticities.

          Are you claiming that we can boost Y in the long run by targeting faster growth of M?

      4. Thankyou ssec – you made my point brilliantly. It is all about real resources.

        It is the daily posts here that seem obsessed about money. I mean are we really worried that the Fed will make financial a loss on QE?

      5. M responds to V.

        V is not stable. It never has been.

        In fact, one can put forward a very valid argument V is in secular decline and M is self destroying.

        Because Western Households have accumulated so much debt, and payments made by the government to households (in the form of stimulus) goes to repaying mortgages. Under that scenario, V = 0. Further,as the private sector trys to delever, depositors transact with debtors and the gross financial assets are destroyed (the deposit eliminates the debt), So under that sceario M < 0.

        That is why, depsite all of the so called "Money Printing" inflation is yet to rear its ugly head. In fact we face a greater risk of deflation rather than inflation.

        1. It could be that lower inflation means that folks are happy to hold an asset with a pretty decent real yield – it is a bit more convenient than a US 5yr real bond, and has a similar real return …

    3. From the introduction of book above:
      “The answer is simple: prices are a collective hallucination”
      PS it Includes the price of money :)

    1. Ah! So, tell me the details on how this fantastic and functional and super-efficient US congress (not like that third-class Zimbabwe, they are not good) would deliver the fiscal stimulus panacea that will save us all! What fantastic new program they will envision. Maybe something like a new “Federal Home Loan Mortgage Corporation (FHLMC),” also known as Freddie Mac, revised and improved?

      1. Well I guess they could start by educating their Kids. Childeren with education actually adds to the productivity and real output of a country.

        Or how about a fully function law and order framwork. This may be a new idea, but crime is a real cost to an economy. Perhaps minimising crime would be an econmic benefit?

        What about fixing up infrastructure. you see, it is a real bummer for productivity when trucks can not cross bridges because they have collapsed.

        Or perhaps you are right. Lets keep cutting back spending, beacuse there is a 0.000000000000000000001% chance we will all end up like Zimbabwe…..

        1. Sorry mate – just busy at work and not checking messages. WordPress has got all picky about comments of late. Had the same issue yesterday. Not sure what it is about. Your comments are fine by me.

      2. OK, I think they should hire 30 million new teachers and pay them with printed money, so unemployment is history.

        Beside jokes, why European countries with large deficits have today crappy, stagnating economies? Where is all that money, invested by governments in very important projects, infrastructure, educations, welfare gone?

        Public spending does not replace or incentivate private spending, it actually kills it.

  3. Let me get this straight. The basic idea is that because interest rates are zero, no one wants to borrow because the only direction interest rates can go is up? So the longer you keep them at zero, the closer the perceived increase in interest rates becomes, and the expected interest rate for new borrowers begins to climb.

    Or is it some of this combined with increasing expectations of increased taxation because of all the publicity around the US debt?

    Doesn’t this really suggest that Keynesian style government spending is a good idea? Don’t give the private sector money, spend it yourself, because the monetary tools are not working and the private sector won’t spend.

    Having now read Fisher’s op-ed, it seems that his concern is that low interest rates discourage lending –
    “we would get less [borrowing] because zero long-term interest rates would discourage lending. There would be no reward for those willing to give up current consumption or liquidity”

    Which again leads to the conclusion that the government should be the borrowing and spending.

    1. Doesn’t this really suggest that Keynesian style government spending is a good idea?
      Yes it does. Moreover, the US government does not borrow in order to spend. It issues its currency, then manages liquidity via its bond program.

      1. Nope, the Fed issues the currency. The Treasury issues the bonds.

        The fed buys the bonds to add liquidity. Asset side is bond, liability side is notes and reserves.

        But i think you know this and are doing one of your jedi mind tricks again …

        What is this twist?

      2. The fed and the Treasury are part of the consolidated government. That is very distinct to Europe where the ECB and Treasuries are not. That is why Europe has been a mess. That is why Japan and USA refuse to go broke.

        The consolidated US government is a currency issuer and can never go broke. Australia is no different.

        1. I think this is where we part. Of course they can command real resources – up to a limit – by issuing currency. Initially, the inflation tax will increase the total resources they can claim. LTer it will lower their claims.

          Push it to the limit, however, and their ‘monopoly franchise’ will evaporate – the private sector will ‘dollarize’ (or whatever it is when the USD cracks – goldize?) and the inflation tax will go to zero.

          At that point fiscal reform is required.

      3. Agree – there is a limit to fiscal spending which is access to real resources leading to inflation. So on that we agree.

        In boom times resources become scarce as the private sector claims them to meet its profit motive. At this time government should run a surplus (un-print money).

        Current times (in the US) do not reflect boom times.

    2. For me it’s very simple. You pay to borrow and spend the money if it’s a perceived benefit. If you like the product that is on offer. Right now the private sector does not like the borrow-money-product. Why is the cost of money so low right now, one wonders? What are the risks? Why me? Remember what happened to our friends just few years ago. And every time a central bank lowers the costs of money, yet again, it sends a message that the product is on sale and no-one wants it. It really must be rubbish.

      Re “Which again leads to the conclusion that the government should be the borrowing and spending”. That’s if you think the government can be efficient in their spending. But the vast majority does not believe that, and with a reason.

      Look, think about the USSR, with an entire economy that was centrally planned… did that work in the long run? And look at China? Will it work in the long run? They’ll soon have exact the same problems as the USSR. Or closer to home… Europe. What have the EU governments done with those gigantic deficits created in the last decade?

      1. “That’s if you think the government can be efficient in their spending. But the vast majority does not believe that, and with a reason.”

        Does it matter? Having 10% unemployment is pretty inefficient as well.

        They also don’t have to centrally plan all spending. They can put various infrastructure projects out to tender for the private sector. Federal governments can delegate to local and State governments to spend as they see fit – perhaps with some education and training investment that fulfils local demands.

        Governments of various levels can ask for proposals from private sector to fulfil local policy goals, like urban mass transportation, waste processing, port expansions, and promoting wide adoption of innovative farming methods. The proposals can be assessed on some publicly scrutinised criteria.

        Government spending does not always imply centralised decision making.

        On your prediction on the problems facing China, I’m not sure we agree.

        In the end, money is simply a tool we humans created to fulfil a social purpose. It is the product of the rules we write – rules that have been rewritten and rewritten for centuries. I personally think we should use that tool to fulfil social goals, such as low unemployment.

      2. Cameron, you might be right, but then I repeat the question above: why European countries with large deficits have today crappy, stagnating economies? Where is all that money, invested by governments in very important projects, infrastructure, educations, welfare gone?

        You seem trust the government and how they allocate public money, I do not.

        Yes, let’s invest in more infrastructure projects, but that does not change the fundamentals. And how many jobs would that create and how long would they last? Again, is it really money well spent? How about instead giving a computer with Internet access to every kid in America? Or a house to every homeless person? Or maybe push more money in Medicare? As b_b says resources are limited, so how do we use them and why would congress know what’s best.

    3. Basic idea is that the portfolio balance effect does not work in the long run, as the private sector still owns the assets.

      To me, it seems like a good time to invest in properly cost-benefit tested infrastructure. The private sector is unable to take these risks at the moment, and rates are low.

      1. I like printing presses. Especially when NGDP is slow far below trend. I’m doing my bit for the US economy! :P

  4. You are printing free comments! You must be government
    I wonder if Ricardo can ever run out of comments? Lets get S&P to give him a rating!

    1. I would guess that the more comments we make the smaller the population of readers who want to read them all … See, it is just like monetary inflation :)

      1. Agree. But we are never limited on the number of comments we can make – no matter what S&P says.

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