Robert Murphy criticized David Beckworth's conservative case for quantitative easing.
For the most part, Murphy fails to understand the quasi-monetarist position. Beckworth correctly understands that the purpose of quantitative easing is to expand the quantity of money, correct the imbalance between the quantity of money and the demand to hold it, and so, expand spending on final goods and services--particularly consumer and capital goods.
Beckworth doesn't think the purpose of the policy is to lower interest rates or expand industrial or commercial bank loans. Murphy's statistics about interest rates on government bonds and the volume of commercial and industrial loans are irrelevant. As I have explained before, quantitative easing can increase spending on goods and services while real interest rates rise and lending by banks or even total lending falls. All it requires is that some of the households and firms that reduce lending use the funds they would have lent to instead purchase consumer or capital goods.
Murphy's argument against the desirability of expanded spending is almost nonexistent. Neither Beckworth nor any quasi-monetarist claims that spending creates wealth without production. Further, we understand the importance of expanding the productive capacity of the economy through saving, investment, and technological innovation However, we also recognize that in a market system, productive capacity will do no good if firms cannot sell what they produce. And so, real expenditure must grow with the productive capacity of the economy. That requires that money expenditures grow or else the level of prices and wages fall. Our view is that growing money expenditures is a better way to allow firms to sell what they are able to produce than requiring a deflation of prices and wages, particularly a deflation made necessary by a large drop in money expenditures.
We cannot "inflate" ourselves into jobs, says Murphy. If we assume that the prices and wages are at the level where the real quantity of money equals the demand to hold it, then expanding the quantity of money will do no good. But if the prices and wages remain too high for the real volume of expenditure to match the productive capacity of the economy, increasing the quantity of money means that prices and wages don't have to fall as much as they otherwise would. In the limit, prices and wages don't need to fall at all and, in fact, can continue to rise at their previous trend.
In the end, Murphy criticizes quantitative easing because when the Fed purchases $600 billion in government bonds, it is purportedly distorting the market by providing the Federal government with funds at preferential rates. By lending to the government, the Fed is distorting the market by directing credit towards the government rather than the private sector.
At first glance, the argument is absurd. Does Murphy really think that the U.S. government will spend $600 billion more in 2010 and 2011 because the Fed is purchasing $600 billion more government bonds? That if the Fed instead purchased a portfolio of private securities, the U.S. Treasury would have to sell fewer bonds over the next year because it couldn't find buyers? And so, the U.S. government would have to limit its spending because of a lack of funds?
I think a much better vision of the current fiscal situation in the U.S. is that the government spends what it likes, collects taxes as it can, and borrows the difference. The U.S. government has no problem finding buyers for its bonds, and is able to borrow at historically low rates.
However, there is probably one element of truth in Murphy's argument. If quantitative easing did lower interest rates on government bonds, then this would reduce the government's interest expense. Because of public concern about budget deficits (which I share,) this reduction in interest expense will reduce the pressure on the government to hold the line on other elements of government spending or increase taxes.
Still, I am not certain that the alternative of the government paying its bond holders more and spending less on other government programs is especially desirable. I am sure that paying its bond holders more and raising taxes would be worse. My own preference is that other government spending should be cut regardless of what happens to the government's interest expense. If there is any change made to the budget due to lower interest expense, it should be lower tax rates.
However, as explained above, quantitative easing might actually raise interest rates and the expense of funding the national debt. When the economy is depressed, investors seek safety, which includes government bonds. Since the point of quantitative easing is to increase spending by households on consumer goods and spending by firms on capital goods, and so, generate an economic recovery, investors should feel less need for safety and may move away from government bonds. That the interest cost on the national debt might rise is a cost well worth paying for economic recovery.
However, having a monopoly central bank direct investment is problematic. The solution is simple. Privatize the issue of hand-to-hand currency, abolish reserve requirements, and set the interest rate paid on reserve balances below the interest rate that can be earned on short term government bonds. This would greatly reduce the demand for base money, and so, minimize the impact of the Fed on investment decisions. The investment decisions would be made by the banks that issue the private currency and deposits used as money or for saving purposes.
The worst possible situation is for the Fed to pay high interest on reserves, causing an increase in the demand for base money, and then directing credit where it thinks best. In other words, the worst possible policy was the misnamed QE 1, really an effort by the Fed to "fix" credit markets. While QE 2 is far from prefect, combined with a commitment to fiscal responsibility, it does not manipulate credit markets in the favor of the government, and is better than leaving the quantity of money below the demand for hold money and real expenditure below productive capacity.
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"Privatize the issue of hand-to-hand currency, abolish reserve requirements, and set the interest rate paid on reserve balances below the interest rate that can be earned on short term government bonds."
ReplyDeleteI don't get this. Is it a complicated way of saying that the Fed should be abolished? If interest rate on reserve balances is lower than the interest rate on short term government bonds, the equilibrium size of the Fed's balance sheet is zero, as short term government bonds have higher yield, they are more useful as a collateral, they have much wider circulation. The only reasons that the Fed has a balance sheet with a non-zero size are that interest rate on reserves is higher than the T-bill rate, it issues hand-to-hand currency, and reserve requirements create a tiny bit of demand for reserves.
If what you have in mind is the Fed with the active role of setting the monetary policy, while prohibiting credit market interventions, you should fix the size of the Fed's balance sheet permanently at modest levels, perhaps allowing for x percent annual growth, and let the Fed manipulate the interest rate on reserve balances to balance the demand and supply of money. In this case the T-bill rate will usually be at lower levels than the rate on reserve balances.
This thing is just a wishful thinking: "While QE 2 is far for prefect, combined with a commitment to fiscal responsibility, it does not manipulate credit markets in the favor of the government", and is a strange thing to hear from a libertarian. In the presence of market frictions, QE 2 manipulates credit markets in the favor of the government. The solution is to have a rule that the Fed should hold a market portfolio of debt securities that approximates the total government and non-government bond universe.
Brilliant.
ReplyDeleteIntellectual gobblydook of the sort that would frustrate Herbert Spencer.
ReplyDelete"If we assume that the prices and wages are at the level where the real quantity of money equals the demand to hold it, then expanding the quantity of money will do no good. But if the prices and wages remain too high for the real volume of expenditure to match the productive capacity of the economy, increasing the quantity of money means that prices and wages don't have to fall as much as they otherwise would. In the limit, prices and wages don't need to fall at all and, in fact, can continue to rise at their previous trend."
What the hell is the "the real quantity of money" and the "demand" to hold it? What are the "real volume of expenditures"? Is this guy so brilliant to correctly identify all he has laid out in the above paragraph?
This reads more like Miss South Carolina 2007 explaining education to the judges than anything Rothbard would write
Makes perfect sense to me, Bill! But then again, I'd rather hear Miss South Carolina talk about just about anything than re-read _The Mystery of Banking_.
ReplyDeleteProf. Woolsey,
ReplyDeleteFirst, I want you to know that I do (rarely) admit when I'm wrong. You caught me in an elementary mistake when I was talking about paying interest on reserves, and I admitted it.
Having gotten that off my chest, I think your response here is goofy. You, some people on my blog, and I believe Beckworth himself (in a piece we're putting on the Mises blog shortly) said that I had mischaracterized Beckworth, that actually he is agnostic about interest rates and lending.
Really? Here is what he wrote:
One reason for this confusion is a failure by some conservative commentators to understand the real purpose of QE2. It is not solely about lowering interest rates, increasing bank reserves, and encouraging bank lending, though all of those will occur. Rather, it is about fixing a spike in the demand for money that has significantly hampered spending.
Maybe that was a slip of the keyboard on his part, but I think you can forgive me for thinking he was saying QE2 would lower interest rates and increase lending.
Final point, about government borrowing and interest rates: Are you making a judgment about magnitudes in this particular episode, with or without QE2? Or are you saying in general, the US government's spending has nothing at all to do with the interest rates it has to pay on its debt?
Robert,
ReplyDeleteYes, I said interest would initially be lowered from QE2. I don't deny that. But I also said later in the article that as successful QE2 would ultimately raise interest rates. This is something I have been saying repeatedly on my blog. For example see here, here, and here. If you look at the evidence I present in the figures in the posts, you will see that interest rates did initially fall as QE2 was talked up, but then soon after its implementation began to ascend. As I noted in the article and in my blog posts this rise should be expected if QE2 actually works to shore up the economy. Just to repeat: interest rates go down, then go up if QE2 works according to plan. This is clearly laid out in the article here:
Note that lower long-term interest rates are not the key to QE2 working. Yes, long-term interest rates may initially drop as the Federal Reserve buys up long-term Treasury securities to increase the monetary base. But this effect will be fleeting if QE2 is successful. Once the economy starts recovering, interest rates will start increasing.
Note that I say (1) interest rates are of secondary importance, (2) they will initially fall, and (3) they will eventually rise if QE2 works. There is nothing agnostic about this. How could you miss this?
As noted in (1), though, interest rate movements are of secondary importance. The key point to my piece was the excess money demand problem which you simply ignored. Why?
Had you not ignored this point, you would have understood that my call for spending was not Keynesian spending spree but a call for creditors, not debtors, who are sitting on the excess money balances to use them. This is very different than saying increased Keynesian-style consumer spending is necessary, which is what you incorrectly attribute to me.
I agree that Beckworth said that quantitative easing would lower interest interest rates and encourage bank lending. It is just that none of those are the "real purpose" of quantitative easing. The real purpose is to raise the quantity of money and expand money expenditures. Whether or not it lowers interest rates and increases bank lending is irrelevant. As I explained in the post, it is quite possible for quantitative easing to increase expenditures while interest rates rise and bank lending falls.
ReplyDeleteThe real quantity of money is Ms/P in symbols. The concept is the quantity of money conceived in terms of its command over goods and services.
ReplyDeleteThe demand to hold the real quantity of money is the sum of the amount of money, in terms of its command over goods and services, that people want to hold.
The real volume of expenditures is MV/P. It is the flow of expenditures on final goods and services conceived in terms of the goods and services purchased rather than their dollar value.
Monetary economists of all flavors, including free market ones, and even including many Austrian ones, would understand these terms. The real quantity of money and the demand to hold is not problematic. Some Austrians don't like adding together the flow demands for different goods and services. Perhaps they have problems with the concept of a real flow too. But others don't.
Anyway, it is all just basic economics.
I don't agree that my proposed reforms-- private hand-to-hand currency, no reserve requirements, and lower interest rates on reserves than T-bills would cause the demand for reserve balances to fall to zero. Reserve balances are useful for clearing checks. I aggree the demand would be very low.
ReplyDeleteIf private arrangments for check clearing (using T-bills, I guess) should arise, then monetary policy would operate in a different fashion. Expansion isn't a problem. The demand for base money is zero, the Fed buys bonds, creating an excess supply. When money expenditures are back at the correct level, the Fed makes an open market sale.
Contraction is a bit more challenging. The Fed borrows a T-bill, and sells it. The Fed insist that the seller's bank cover the claim with base money (of which the bank has none.) In other words, the bank has an overdraft on its empty reserve accout that the Fed demands be settled. That bank contracts, and deposits items and settles its balance, but some other bank is now short.
When money expenditures contract the necessary amount, the Fed buys a bond. When it comes time to pay back the T-bill it borrowed initially, it uses that T-bill to pay it back.
If the penalty for these overdrafts is mild, banks would presumably keep zero reserves if they had some alternative means of settling net clearing balances. If, on the other hand, the penalty is steep, then they will keep reserves all the time. And maybe even use them to clear checks.
As for preventing the Fed shifting credit to the Treasury, the way to control that is through a balanced budget rule on the Treasury. The Treasury doesn't borrow more when the Fed buys its bonds rather than someone elses because the Treasury doesn't profit maximize but is constrained by contitutional rules that limit its borrowing.
Prof. Beckworth,
ReplyDeleteYou said:
"Yes, I said interest would initially be lowered from QE2. I don't deny that. But I also said later in the article that as successful QE2 would ultimately raise interest rates. This is something I have been saying repeatedly on my blog. For example see here, here, and here. If you look at the evidence I present in the figures in the posts, you will see that interest rates did initially fall as QE2 was talked up, but then soon after its implementation began to ascend."
Forgive me for making this accusation, but I really think you are trying to cover up a huge blunder you made, and you, for whatever reason, refuse to admit that you were wrong.
In your other article, you said that interest rates would rise after QE2 is all said and done, and the economy is back on track. That was your original call for when interest rates rise. You also said that interest rates would initially fall after QE2.
Now you are completely doing a 180 and claiming that when you said interest rates would rise, you really meant that they would rise immediately, as in, right after QE2 began. But that is a contradiction. You never claimed anywhere that you expected interest rates to gradually fall as QE2 was "talked up" prior to its official announcement, after which rates would start to rise.
You said rates would start to rise after the QE2 program finished, and the economy was back on track. That means the time horizon here is much further into the future, relative to the start of QE2, not the very start of the QE2 program.
You stated on January 11th:
"As I and others have said before, a truly successful QE2--one that helps revive the economy--should ultimately lead to higher bond interest rates."
How in the world could a truly successful QE2 program be "successful" pretty much the day it was announced, which is when interest rates rose?
Prof. Murphy even admitted that he was wrong about things, namely the interest on reserves, in order to show you that he thinks it is OK to admit when one is wrong.
Just do the intellectually mature thing and admit that you were wrong about what would happen to interest rates because of QE2!
Good post Bill.
ReplyDeleteCaptain Freedom: The standard Keynesian argument is that *if* QE2 worked, it would work by lowering interest rates.
I've been reading David Beckworth for some time. David's view (along with a few other economists) has been to question the standard Keynesian view, and point to countervailing forces in which QE2 would push interest rates up. But we were never sure if those countervailing forces would be strong enough and quick enough to kick in immediately, or with a short lag.
It's bizarre that you would accuse David of dishonesty, just as the facts have proven him right!
Nick:
ReplyDeleteYes, the standard Keynesian argument is that if QE2 "worked", it would reduce interest rates.
But we're talking about Beckworth's argument, which is incidentally the standard Keynesian argument. He argued that interest rates would initially fall. They did not initially fall, they initially rose, and have been rising since the beginning of the program.
He tried to get out of this dilemma by (I am saying not honestly) insisting that his original claim of rising interest rates in the distant future, after the full QE2 program had its full impact on the economy, somehow now applies to the day the QE2 program started.
In other words, his initial call was falling interest rates in the short term after QE2, and only after the economy was back on track, once the QE2 program's effects were fully integrated into the economy, will interest rates start to rise again.
How in the world could the effects of QE2 be incorporated into the economy and turn it around THE DAY it was announced?
Beckworth is now saying that what he really meant was declining interest rates during the "talking up" of QE2 before it happens, to immediately rising rates as soon as it starts. But that is NOT what he originally stated in his original article that Murphy challenged.
The facts are NOT consistent with Beckworth's calls. The facts have proven him wrong, and now it appears he is trying to change what he originally wrote by changing the meaning of his arguments.
It is impossible to claim lower initial interest rates after QE2, and higher future interest rates after the effects of QE2 were absorbed in the economy, to a very different claim that is immediately rising interest rates pretty much on the day QE2 was announced, and interpreting this as "well, the economy must be recovering as I said". That is not honest and he should admit he was wrong.
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ReplyDeleteCaptain Freedom,
ReplyDeleteI am not sure where you are getting it, but I never said interest rates would only rise once QE2 is finished. QE2 is a gradual 6-month (maybe longer) process during which interest rates should gradually rise as QE2 gradually shores up the economy. QE2's success is measured over the entire program, not just at the end. Thus, when the 10-year treasury real interest rate started to rise in November it was a sign that QE2 was already working to raise economic expectations. In that sense it was successful soon after it was officially launched. However, QE2 needs to stay successful over the entire program. If it does the real interest rate should continue to go up. This understanding is implied by the January 11 quote of mine you provide.
Given all the posts I have done on this topic there should be no confusion as to what I mean. I have consistently said interest will rise if QE2 is successful. And again, this rise should occur over time since QE2 is gradual process. I have never said it would be an all-or-nothing event at the end of the QE2.
Finally, when I wrote in my article QE2 is "not solely lowering interest rates... but it will occur" I never said in that paragraph it would have to happen after QE2 was officially announced. You assume I must have meant the official date, but why? Like most economists, I look to the defacto start of the QE2, when it was priced into the market. Again this understanding is nothing new and is evident from the broader context of my writings.
"Contraction is a bit more challenging. The Fed borrows a T-bill, and sells it. The Fed insist that the seller's bank cover the claim with base money (of which the bank has none.)"
ReplyDeleteThis is economically equivalent to an increase in reserve requirements.
The case against the small-balance-sheet Fed rests not on the issue of effectiveness of monetary policy. It rests on the risk of policy errors. In May 2008, Bernanke felt that the risk of policy errors has increased due to the financial crisis, and he is less sure about the optimal quantity of money than before. So in May 2008 he requested powers to pay interest on reserves. He wanted to permanently increase the money supply to prevent the deflationary scenarios, and he wanted interest on reserves to control inflation. Unfortunately, the Fed acquired the powers to pay interest on reserves too late, and a switch to a new policy framework occurred at the time of macro volatility. By the way, volatility of inflation expectations was lower in 2008 in eurozone and UK, as their central banks had longstanding powers to pay interest on reserves.
Captain Freedom clearly has not read Beckworth's work and misconstrued his NR article. Beckworth was way too gracious in his reply above. I wonder if Captain Freedom will live up to his own standards and admit he was wrong about Beckworth.
ReplyDeletePart 1/2
ReplyDeleteDavid Beckworth,
You're very clever, I'll give you that, but sorry, this is no better. Your reinterpreted "prediction" would then be correct no matter what happened.
If 10 year interest rates fell, and kept falling, then you would be here saying that you were correct to say that rates would initially fall, but the effects of QE2 have not "ultimately raised rates" (your words) yet, so let's wait a little more for QE2 to really have an impact.
If 10 year interest rates rose, and kept rising, then you would be saying what you are saying now, which is that you were correct to say that rates would initially fall (which is actually false, they did not initially fall, they in fact rose), and then "ultimately rise" once the effects of QE2 spread. You now claim the positive effects were instantaneous, as soon as QE2 was started!
Since rates did not initially fall, you were wrong to claim that they would initially fall.
In short, you are trying to have it both ways. You are trying to reinterpret what you originally said in such away that no matter what happens, you would be right. That strategy could have worked if interest rates did initially fall, but because they did not initially fall, but rose right away and have kept rising, your prediction that they would has been proved incorrect.
Furthermore, you also claimed that bank lending would rise because of QE2. But bank lending has fallen, not risen. Does that mean that we have not yet experienced the effects of QE2 in bank lending, because QE2 has not yet taken effect, but somehow we have experienced the effects of QE2 in interest rates, because QE2 has taken effect?
You ask why should we consider the official announcement of QE2, and not when QE2 was "priced in" by the market, which is the "de facto" start. Well, that is a valid argument, but it cannot support your actual position, because a successful QE2 program as viewed by the market would have priced in higher 10 year interest rates, initially, and not lower interest rates, initially.
Part 2/2
ReplyDeleteDavid Beckworth,
But the market according to you priced in lower interest rates initially, prior to the announcement, during the "talk up" of QE2, and then after QE2 was officially announced, rates went up...because it was "successful". This argument makes little sense.
The reason why the Fed, you, and many others expected interest rates to fall initially is for the same reason you and most others, in your broader writings, expect rates to fall when the Fed purchases bonds. It's because the Fed represents an additional demand that did not exist before. A major reason why the Fed chose to buy long term bonds was precisely to lower long term interest rates. They were surprised when long term rates shot up. And I argue that you were surprised too. You are now claiming that what you said would "ultimately" occur for long term rates as a result of QE2 all of a sudden happened right away.
You are now trying to change what you originally meant in your article and in your broader writings into a different argument, which was that when rates rise, which was supposed to happen "ultimately", after QE2 helped the economy get going (which by the way cannot possibly be the day it was announced, no matter how much you think it is possible, since according to you the main purpose of QE2 was supposed to boost aggregate demand, but this cannot take place until the money created by the Fed for QE2 is actually spent in the economy, which means it cannot do what it is meant to do before the money is even created!), that you expected them to rise right away.
In other words, NO MATTER WHAT HAPPENED, rates going up or down, you were right. But this cannot be reconciled with what you originally said, which is that QE2 would lower rates, as well as increase bank lending, BOTH of which have been proven wrong.
The main reason why I am "harping" on this is because you seem to not be able to admit when you are clearly and unequivocally wrong. What you said was very clear, and what happened was the exact opposite.
Anonymous,
ReplyDelete>Captain Freedom clearly has not read Beckworth's work and misconstrued his NR article. Beckworth was way too gracious in his reply above. I wonder if Captain Freedom will live up to his own standards and admit he was wrong about Beckworth.
Sorry Anonymous, but plain English is plain English. Murphy was way too gracious to Beckworth.
As for living up to my own standards, yes, I do admit when I am wrong:
http://consultingbyrpm.com/blog/2011/01/can-austrian-business-cycle-theory-explain-construction-employment.html#comment-10466
Beckworth should too.
Captain Freedom:
ReplyDeleteI am not trying to change anything I said. You continue put meaning into what I said that simply is not there. I am sorry you cannot see that. I admit when I am wrong and have done so on my blog before. But this is not a case. We will just have to agree to disagree on what I originally said.
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ReplyDeleteCaptain Freedom:
ReplyDeleteI should stop, but one last thing. You said
A major reason why the Fed chose to buy long term bonds was precisely to lower long term interest rates. They were surprised when long term rates shot up. And I argue that you were surprised too.
Quite the opposite--it confirmed what I had been arguing at my blog. For example, in this November 17 post I argued that rising yields was a sign that QE2 was working. In another November
post I criticized the Fed for marketing/selling QE2 as a monetary stimulus program that would lower interest rates. How could I make these arguments and be surprised to see interest rates go up?
On the real (not nominal) rates going up quickly there is a good reason for it happening. If the market suddenly believes the economy will be stronger in the future it will increase, ceteris paribus, current real rates. To the extent QE2 help improved the economic outlook then QE2 did raise real rates rather quickly.
I hope this clarifies things and helps you see that I have been consistent all along in my statements.
David Beckworth,
ReplyDeleteThere is no question that you expected rates to go up after QE2's effects are integrated into the economy. I don't dispute that, because your words are there as proof in the pudding.
The main point that I am making is that you DID in fact say that rates would initially fall, and you DID in fact say that bank lending would increase, as a result of QE2.
I am simply repeating what you in fact said. You said that rates would initially fall, and that bank lending would rise. NEITHER OF THOSE TWO THINGS HAPPENED.
Interest rates initially ROSE, and bank lending FELL, both the exact opposite of what you said would happen.
My blathering on about when your call for rising rates would actually take place is really secondary to the main point, although I still do not accept your case, because your two blog articles posted are dated in late November. It is your National Review piece that I find myself scratching my head. In that piece, you wrote:
"One reason for this confusion is a failure by some conservative commentators to understand the real purpose of QE2. It is not solely about lowering interest rates, increasing bank reserves, and encouraging bank lending, though all of those will occur."
You implied here that lower interest rates and greater bank lending WILL occur, implying that the expectation of rising rates has not taken place yet, and you appeared to have said this in early December.
If you argue in one piece that QE2 should lower rates and raise lending, and in another piece you say that QE2 should raise rates right away because the market priced it in already, then there is an unavoidable contradiction there.
You even said in your November 17th piece:
"While it is true that rising inflation expectations may temporarily lower real interest rates too and thus stimulate interest sensitive spending, this effect is of second-order importance and is only temporary."
Interest rates did not fall even initially, they rose almost instantly.
Could the discrepancy be a case where you mistakenly believed QE2 would work as planned, and are now trying to tell a story of success by reinterpreting the data to be consistent with it being a success and not a failure?
I submit that because QE2 was expected to lower interest rates, and increase bank lending, it can be interpreted as a failure because neither occurred.
If we can't agree on interest rates, then at LEAST admit that your expectation of rising bank lending was wrong.
Finally, and most importantly, I really enjoy your writings and I find you to be highly informative and enlightening. I just really enjoy bantering with people who are clearly intelligent. It helps my learning process, as much as it APPEARS as vitriolic and spiteful. I mean it all in good fun.
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ReplyDelete