QE discussion fun

Last week I was away from the internet and work – as I was trying to finish off my paper for the NZAE conference this year.  So I missed this post by Cochrane (including a bunch of great comments) and a reply by Sumner.  Yah.

I’d note something that doesn’t come from these posts – some other people are simultaneously saying QE does nothing to increase NGDP, and that it creates asset bubbles.  This argument is far from clear to me, if QE is doing nothing because it is merely a swap of assets with the same yield with no macro impact then why do asset prices change?  Isn’t the increase in asset prices partially due to a lift in expected NGDP growth.  “Bubble” isn’t an answer to everything – we sort of need to understand where it is coming from.

I am sort of hoping some people may stumble here to tell me what I’m missing 🙂

Update:  AAMC on twitter reminded me about this post, which I’d seen as well.  The Cochrane post and comments are, to my mind, a discussion on the same sort of issues – and the Sumner post is a reminder that we have to think about the monetary policy rule and the expectations channel, and base money is special because it is a medium of account (I’m a bit nervous here, as I suspect T-bills are also seen as a medium of account in a large number of contexts, which takes us back to the Cochrane post).

All in all, the debate about QE as a mechanism is important.  Thank goodness we are not in this situation in NZ.

  • Raf

    It creates a portfolio rebalancing effect. Yields fall across the curve, profits are re-leveraged, and the funding for trading becomes extremely cheap. The idea is that higher asset prices will raise confidence, generate profits and may entice the real economy into new borrowing and investment. So it is a monetary policy response (lowering rates) but it’s focus is the whole yield curve, not just short end rates, which are within central banks direct control.

    One problem with the asset swap approach is the specter of future reversal. I’d hazard a guess and say this is unlikely to be re-wound but could be used as a method to cool an overheated economy. I wouldn’t like to be around when the bond market reverses. Will make 1994 look like a picnic.

    The main issue is that they implemented a policy which had two foci: lowering rates AND liquifying balance sheets (rescuing the banks). So they tried to deal with a liquidity and solvency problem at the same time plus the resulting collapse in real economic activity. It’s therefore relying on rising asset prices to drive new investment. The problem with that is that it does tend to distort prices across the economy (housing for example).

    It’s a bit like banks buying sovereign bonds in Europe and funding that with cheap wholesale money. Money for old rope? Perhaps not.

    • Indeed – as Mervyn King was saying to some degree this involves moving returns on assets “forward”. However, I fear that the discipline is getting a bit lost in partial equilibrium logic is they see this as the entire purpose of QE.

      I can’t help but look at this through the prism of a monetary policy rule, that is meant to deal with issues of co-ordination that lead to “insufficient” aggregate demand. Ultimately, the expectations channel in this sense is supposed to be “self-fuffiling” whereby the lift in output comes from the utilisation of underutilised resources. The portfolio rebalancing effect is the “spark” for a broader cumulative lift in AD.

      As a result, if we are talking about an effective tool – the direct impact of the porfolio rebalancing effect should be nothing compared to the solution to this co-ordination problem. In the same way we view the impact of changes in interest rates. And whether it solves this purpose is an important question – one Scott Sumner would say is shown by the impact on market pricing (in terms of forward looking inflation and NGDP expectations).

      The bank subsidy line is important – but that is a separate issue in my mind. One that needs to be tackled for the sake fairness rather than countercyclial monetary policy 🙂