The crux of the problem is that the Fed is "pushing on a string" - playing with the supply side of money while having absolutely no effect on the demand side.
Thomas Palley [1] sums this up nicely in a 2011 critique of QE:
The underlying problem is structurally deficient demand caused by thirty years of neoliberal economic policies that have undermined the income and demand generation process (Palley, 2009). However, rather than fixing this problem, policymakers are again turning to ultra-easy monetary policy in the form of QE. Viewed from this perspective, QE can be interpreted as a form of asset market trickledown whereby supporting asset prices is supposed to jumpstart the macro economy…From a political standpoint, this is an enormous change from the world of forty years ago. The New Deal policy paradigm of wage floors and household income supports has been replaced by one of asset price floors and asset market subsidies. Viewed through a political lens QE therefore represents the triumph of plutonomics, and that makes it an obstruction to the extent it obscures the challenge of repairing the income and demand generation process.
The Fed has dug itself into a hole with QE, where it is losing the ability to control anything in the economy due to the lower 0 bound of the FFR and the economy's inability to handle an interest rate hike.
It is up to the Federal Government (which, democratically speaking, means we the people) to adopt New Deal-like investments in infrastructure, R&D, education, and tech to seed long-term prosperity in order to rebuild an economy with a strong middle class that will demand loans for things like mortgages, appliances, cars, and machinery, as well as drive invention and wealth creation rather than rent-seeking & arbitrage as we are seeing today.
>playing with the supply side of money while having absolutely no effect on the demand side.
This is a strange position to take on a website that glorifies start ups. Cheap capital can unlock demand by lowering barriers to entry.
People looking for investment opportunities fund companies like Uber. And uber turns around an creates massive demand for private adhock drivers.
That sort of incentivize won't reverse a recession like deficit spending can. But it has a real effect.
The critiques of QE never really panned out.
>The Fed has dug itself into a hole with QE, where it is losing the ability to control anything in the economy due to the lower 0 bound of the FFR and the economy's inability to handle an interest rate hike.
The fed always has the option of last resort. Actually printing money and buying debt from government directly.
HN is a strange and wonderful place full of all kinds of people with all kinds of opinions on startups.
And yes, easy money can help unlock demand, but it can't generate it in a sustainable manner.
> "Actually printing money" - and then what? Dropping it to the eager consumers out of helicopters? [1] They've given banks all the money they need, and then some. Banks act as the gate keepers of loans and investments within the economy, vetting those who are likely to pay back. That is their business.
They are not finding enough demand within the economy to push out more money, even with short-term interest rates near 0 for the past 6 years. So they sit on it, earning 0.75% on their reserves.
The Fed does not have the power to solve this problem, in my opinion.
QE1 worked, in that it saved us from a depression. But the jury's still out on whether that was just a can kicking exercise to be reckoned with at a future date. The other QE's by any measure, have been a failures, at least when compared to QE1.
And when almost all major global economic indicators are looking negative, it's hard to talk about QE in terms of it being successful policy.
I recommend that you read the linked paper, where Palley highlights the 5 channels through which QE should have had an expansionary effect on the economy, according to Keynesian economic theory (hence the name of the paper).
Here are the 5 channels:
1. A traditional Keynesian interest rate channel whereby the Fed purchases long-term bonds in order to reduce the long-term interest rates as it is unable to further reduce short term rates (zero lower bound)
2. The Tobin’s q channel whereby some of the liquidity is directed to the stock market, increasing stock prices and investment in turn
3. A wealth effect that increases consumption brought about by higher bond and equity prices
4. Expected inflation brings forward consumption and investment spending as households and firms purchase in the present rather than in the future when money is expected to lose real purchasing power (increased velocity of money due to inflation)
5. Increased net exports whereby some of the liquidity is used to purchase foreign reserves, decreasing the exchange rate and devaluing the dollar
I'll leave it up to you to research whether or not these 5 channels have been effectively manipulated as Keynesians would have predicted through QE. But I have a feeling you already know the answer...Bonus points if you can answer this question: Why did channel #2 work so well, and why haven't we seen the supposed wealth effect (#3) predicted under a burgeoning stock market?
Not an economist but let me try to see if I really have as good a handle on all this macro-economic stuff as I like to think I do.
Ok. My guess is that QE goes directly to banks. Banks should start lending. QE is inflationary so the economy artificially grows and exports are helped cuz the $ gets cheaper but imports are hurt. This is not so bad for the $ because it is the world's reserve currency and a lot of commodities are traded in it.
Anyway, for some reason, the institutions don't lend the QE money into the real economy they buy portfolios of stocks because the return is greater and the risk is lower. That's my guess. I suppose for proper bonus points I need to be able to say why the stock market seems like a better bet than the real economy. And maybe #3 hasn't panned out because companies aren't paying dividends like they ought to.
In Silicon Valley it would be like a company that is raising record amounts of money at mind-boggling valuations but whose revenue isn't growing at the same pace.
One of the major question marks has been wage growth during the recovery. Stock markets have been skyrocketing, but wages have generally remained stagnant.
Similarly, labor participation (i.e. of the people who could work, how many are actively looking/employed) has remained worryingly low. While the US unemployment rate is very low (~5.1%), that isn't a direct inverse of those who are employed. There is a huge group of people who have simply given up trying to find work and others who are working but less than they would like (e.g. part-time, have one job but would like to work another/overtime, etc.)
We see that effect on inflation, which is no where near the 2% level that the Fed would like. Inflation crudely correlates with real growth because it encourages spending; if the money I have will be worth less in the future, I'm more likely to spend it today.
So in effect, we look at the S&P and think "Awesome! We're at all time highs!" But then we look at the economic fundamentals for people and it looks less sketchy.
Don't you mean "more sketchy", as in we look at the S&P and think "Yay" But we are getting dubious signals from the so-called real economy that do not correlate with the signals we are getting from the stock market. Hence, "more sketchy", no?
I'd venture to say that our wage and labor problems have less to do with the economy itself and more to do with a shift in global demand and specialization. All of those manufacturing jobs are going to China (whether we like it or not, China's labor costs are probably always going to be more cost effective for business), and the US labor market is demanding more skilled labor. We have an enormous oversupply of unskilled labor that isn't meeting the shift in labor demand.
Instead of using politics and complex tax systems to try and gain back those manufacturing jobs, I wish our government would focus more on helping our workforce adapt to the things where our country can have a competitive advantage in the world: education, technology, engineering, etc.
Any mention of the Fed on HN seems to come with a generous helping of heterodox complaints about QE. I'll just point out that despite throwing everything at the wall for 6+ years they are all still batting zero.
There are so many smart people on HN, such as yourself (and not being sarcastic!), with wide ranging expertise. I think we can crowd source some improvements right here.
I claim no special skill or insight into economics, I'm just tagging these posts so people don't mistakenly think that what is presented is mainstream economic theory. Based on our experience in the last decade, as a first order approximation heterdox claims about QE unsupported by evidence should be greeted skeptically.
Because there’s no one buyer big enough to purchase them. The Federal Reserve itself is now the world’s largest holder of US government debt, after its bond-buying programs pushed its holdings above those of China.
In an otherwise interesting and well written article, this is just an absurd statement. They are under no obligation to sell all of them. They can sell whatever amount is appropriate to lower the price (and raise the rate) to where they want it. Further, toward the end of the article, it is suggested that they might have trouble raising the long term rates even if they are able to successfully raise the short term rate . . . well, duh, sell some of the long term treasury bonds.
Interesting point. Of the $2.46 Trillion of treasury holdings, $638 Billion have a duration of 10+ years [1]. Of the $1.7 Trillion of MBS, not surprisingly almost all are over 10 years.
That 10% reserve number is interesting. I learned about the 10% reserve ratio in macroeconomics class, where I also learned that there's this thing called the money multiplier. See, if banks are required to hold a fraction r (10%) of their deposits in reserve, then obviously they'll lend out the rest, which will in turn be held or spent by the borrower, and one way or another it'll end up back in a bank. So a (1-r) fraction of the actual cash and Fed-issued money ends up lent out and redeposited. But the banks can loan out a (1-r) fraction of /that/, ad infinitum. So the total amount of deposited money is 1 + (1-r) + (1-r)^2 + ... = 1/r of whatever money (cash and things actually deposited at the Fed) the Fed created in the first place. Since r = 10%, the multiplier is 10.
> There's really no limit on how much [money] banks could create, provided they can find someone willing to borrow it. They will never get caught short, for the simple reason that borrowers do not, generally speaking, take the cash and put it under their mattresses; ultimately, any money a bank loans out will just end up back in some bank again. So for the banking system as a whole, every loan just becomes another deposit.
> What this means is that the real limit on the amount of money in circulation is not how much the central bank is willing to lend, but how much government, firms, and ordinary citizens, are willing to borrow.
...
> Just consider what might happen if mortgage holders realised the money the bank lent them is not, really, the life savings of some thrifty pensioner, but something the bank just whisked into existence through its possession of a magic wand which we, the public, handed over to it.
The documentary "Four Horsemen" (link below) goes into these topics at length, especially money creation. Most people's jaws drop when they learn that 97% of all money in the world isn't in paper/coin form but rather 0s and 1s in a database and that it is all willed into existence as debt by a bank.
I don't see any inherent problem in having the sum of all deposits far exceed the actual amount of cash in existence. I do find it odd that the Fed and Congress permit the banks to exert strong control over the total money supply by adjusting how much cash they hold in reserve rather than having the Fed itself control the money supply.
Of course there is an inherent problem with it: it's fraud. Just because it's fraud we are used to doesn't make it any less so.
Demand deposits should be covered via reserves. Loans by banks should be duration-matched to financial instruments offered to the public. Presto, no bank runs and the interest rate is driven by a market expression of societies time preferences.
Economic stimulus is done via government spending, rather than jamming money into an already bloated financial sector. I would favor a universal citizens dividend for this, to minimize corruption.
Some have argued that the reserves no longer exist in practical terms. [1]
[1] http://www.ny.frb.org/research/epr/02v08n1/0205benn/0205benn...
tl;dr "They attribute the diminished force of the requirements largely to the spread of "sweep" arrangements—a banking innovation that allows depository institutions to shift funds out of customer accounts subject to reserve requirements."
With sweep accounts, the reserve ratio is far, far worse than 10%. This is why we are screwed: we've been expanding the fractional ratio for 60 years and it's finally starting to matter as the U.S. economy slows and stops growing fast enough to paper it over.
Keep in mind also that the 10% reserve doesn't mean physical money (paper/coins). When a bank loans money, it can create $9 out of thin air for every real $1 it holds (be it in paper or in DB entry). When loans are being paid back, the banks count that payment as "real" money against which they can loan 9x the value again. In theory at least, this process can repeat to infinity.
I wonder if anybody unit tested this design for flaws.
> This is why we are screwed: we've been expanding the fractional ratio for 60 years and it's finally starting to matter as the U.S. economy slows and stops growing fast enough to paper it over.
If the above was the problem, then the below wouldn't matter:
> There is no exit. The Fed cannot raise rates.
Because the Fed wouldn't be considering raising rates. If the US economy is growing too slowly, the Fed generally seeks to lower rates, not raise them.
As long as a loan is collateralized by an asset that a reasonable market would value at or above the amount of the loan, the only issue is liquidity...right? So whether the ratio is 10%, 2%, etc. is kind of irrelevant. If folks want their money all at once, no reserve requirement would be sufficient. But at least the idea here (not that it has been followed) is to keep things stable enough so no large group runs for the exits and so long as conditions are maintained that don't foster those runs, the system should work.
That is not correct. For demand deposits there should be a 100% reserve requirement. No bank run is possible: if everyone shows up and wants the money they are legally able to demand at a given moment, it's all there.
Loans are then (strictly) duration matched with financial instruments offered to the public. Collateralization provides the banks with assets to offset the inevitable bad loans, but "investors" can't demand their money back earlier, and the banks had damn well better be on point when it comes to making and managing the loans, or they are out of business. There would be a secondary market for these instruments, of course.
It's pretty straight forward when you just think in terms of contracts. Its a testament to how fucked up (or, perhaps, effective) our education system is that smart people like yourself can't see these problems straight away.
Well written, thank you. It's beyond my understanding why the fractional reserve banking is allowed by western societies. Why should banks be able to do this, but not other companies or even private persons?
>Why should banks be able to do this, but not other companies or even private persons?
Companies and individuals are most certainly able to create "money" on their own. You can issue all the debt you want, as long as you find a willing counterparty and sign your own name to it. It's balance sheet expansion.
For example, you go to purchase a new car, and sign a note telling the dealer that you will pay the price of the car, plus interest, over five years. You've created an asset out of nothing, for which the bank is more than willing to pay the dealer cash for. People and companies create such assets every day. There is no magic to issuing your own liabilities, which is what the Fed does when it prints money.
Unions and monopoly is bad. Competition is good. Except for lending and money creation. Banks must have monopoly on that, because.. shut up and go to work.
> Why should banks be able to do this, but not other companies or even private persons?
Other companies besides "banks" (savings and loans, credit unions, etc.) can. Other other companies and private individuals only can't in the sense that there are rules governing this to prevent abuse, and if you jump through all the hoops required to do that, you have become a bank, savings and loan, credit union, or some other entity allowed to do it. Banks, etc., are just the name given to entities that have met the requirements to engage in particular activities.
The fractional reserve system on its own is not necessarily the issue so long as those making the loans fairly value the assets that collateralize the loan. Which also dictates that the loans be collateralized in the first place :)
They do it without asking (the Federal Reserve Act was passed Christmas Eve 1913 - around the same time the IRS came into being, what a coincidence) and most people do not understand the harm in it (even here on HN).
> If the Fed tried to sell its bond portfolio it would likely tank the market and cause interest rates to spike, undoing much—if not all of—the beneficial economic effects its efforts have achieved over the last few years.
Isn't that exactly the goal? To "raise interest rates"? I mean, the solution to the problem is the thing that they can't do? I don't get it. It makes no sense. The argument is circular.
If rates would spike too much -- which is the same as saying bond prices are falling -- then all they have to do is slow the rate at which they're selling the portfolio.
The problem is that the Fed must corner the market in Fed Funds in order to meet their objective. They must set the price floor. In the past, this market was small and controlled by the Fed.
Their current limit is $300B - what happens when say, $4 trillion dollars shows up asking to be paid at the Fed's targeted rate. If the rate were 0.5%, that would be $20 billion a year that the Fed would need to pay out. If they limit it to the first $300B, then they cannot hold the rate at 0.5%. Can the Fed pay $20B in interest a year?
IMHO, long way of saying, after taking the economy to ZIRP, the Fed has to find a safe way to drain the system of excess reserves before they regain control of Fed Funds.
"The Fed is by definition the safest place to put your dollars in the world—because it has the ability to create any money in might need to pay you back." This is fantastic. "The Fed can only pay interest on reserves to one type of institution: banks" This is not fantastic. Why can't I as a simple citizen, put my money at Fed and take advantage of the safest interests ever known to man ? This discrimination has to cease or am I missing something ?
This is pretty much exactly what the banks are doing, albeit at a larger scale. They buy T-Bills, or other equivalents such as Gilts (UK government backed bonds) as they're as secure as investments get - with reduced returns as the compensation for the increased security of the bonds being backed by one of the worlds major economies.
Because the system is designed for banks with large sums. If you want similar protection for your money while accruing interest then you can buy government securities (notes, bills and treasuries).
So then the obvious solution is to create your own bank and start depositing money in the Fed. If you can't create a bank, you could probably buy one. I know a YC company that was trying to do that, so it can't be that hard!
So first the fed cut rates and many people called them unprincipled and we would have run away inflation "just around the corner" and they were shown to be quite wrong. Now these same people are calling for raising rates what traditionally used forms of data suggest is at least a little too early and there seems to be a possibility that the fed is going to raise rates.
Creating money out of thin air ends up devaluing the currency that is currently in circulation.
My understanding is weak and I'm still not clear whether the Zeitgeist Movement's position on the matter is correct, but I'd recommend watching the second of the Zeitgeist Movement's video on the matter to enrich your opinion.
Not necessarily. Over the past seven years the monetary base has expanded significantly, yet inflation has remained super low.
It's true that creating money out of thin air increases the supply of money. But the price of money is not set by one factor of supply alone. You also have to consider the velocity of money (affecting supply) and the demand for money. If these are changing too, then you can certainly increase the supply of money without devaluing the currency.
Also you can have counterintuitive effects where increasing the supply of money stimulates the economy increasing the demand for money thereby strengthening the value of the currency overall.
> Creating money out of thin air ends up devaluing the currency that is currently in circulation.
To some extent, compared to not doing so, it does. But whether the extent a particular injection does this is undesirable or not depends on conditions, and manifestly the large injections of money by the Fed over recent years have not resulted in significant inflation.
Exactly, otherwise Greece and other countries wouldn't have been locked out of the commercial markets if they could set rates. German rates were/are low because the German economy is thought to be a decent shape, Greek rates are high because the opposite.
“The committee is confident that it has the tools it needs to raise short-term interest rates when it becomes appropriate to do so,” Fed chair Janet Yellen told Congress earlier this year, adding, “and to maintain reasonable control of the level of short-term interest rates.”
subtext - Keep a close eye on this situation, as it may require popcorn and a safe viewing platform.
You may want to explain more about why you feel that way for people who don't have insights into your personal viewpoint or the broad arguments for that matter :)
I agree. Too often sweeping viewpoints are made without data. The crazy part is this is not some grand hidden conspiracy, the data is out there to explore and use to support arguments for and against the fed. [1][2]
Agreed, there is no conspiracy here. Just a series of systemic flaws. What's scary is that there needs to be a discussion on this but few economists are brave enough to voice their concerns. David Harvey, Steve Keen, and others are stepping up but we need more people.
Most central banks dictate that there should be 2% inflation, which means the economy needs to grow 2% per year. But we live in a world with linear resources so unless we talk about virtual goods the economy cannot grow that much and still be sustainable over the long run. Basically it will violate a nature law which says we cannot ventilate that much heat into space as the economic growth requires.
"At that 2.3% growth rate, we would be using energy at a rate corresponding to the total solar input striking Earth in a little over 400 years. We would consume something comparable to the entire sun in 1400 years from now - See more at: http://physics.ucsd.edu/do-the-math/2012/04/economist-meets-...
Further the FED is privatly owned by banks.
Economics is trying to violate nature laws, it cannot do that so the current system will fail. A new sustainable economic system will emerge.
As several people keep hammering into my head, inflation is not the same thing as what people would consider "growth".
Depending on your school of economic thought, inflation represents the increase in money supply. So, if I took away every $1 bill and replaced it with a $100 bill, the willingness of everyone to now pay $100 for a coke is inflation.
It seems to be an accepted principle that we want to keep people from hoarding cash, so inflation of ~2% is wanted. It gives everyone a nice buffer to avoid dipping into deflation.
Inflation needs to remain on par with growth so that $1 (or whatever unit of currency) remains valued at $1 as more value is created within the economy. The total of an economy's currency represents the total value within that economy; think a pie, where the number of slices is the currency representation of the totality of the pie. If the money supply does not increase as the economy grows, then each currency unit effectively stretches to represent more value: as the pie gets bigger, but the number of slices doesn't change, then the value imputed to each slice grows. If the money supply grows but the economy doesn't, the value of each currency unit decreases: the number of slices increases, but the amount of pie per slice decreases. If the currency supply increases on par with the economic growth, the value per unit remains the same while the total value of the economy increases: as the pie grows, you want to increase the number of slices so that each slice has the same amount of pie, even though there is more pie total.
When inflation exceeds growth, people get distressed as their "slice of the pie" gets smaller. When growth exceeds supply, people get distressed as it gets harder to obtain a slice of that pie. And the problem with the Fed conjuring virtual currency out of thin air is it makes each slice of the pie smaller without the pie growing...giving the Fed, and their cronies, a bigger chunk of the pie without earning it.
Point taken about inflation. But the thermophysics part still hold true though. You cannot increase economic output a lot without using more energy which will make earth boil.
The economy doesn't follow natural law, or - in many ways both literal and figurative - any laws at all.
If you think it should, then it'll appear to violate all sorts of principles all the time. In some cases it behaves like a closed system (employment in countries), in others it's an open system (companies). Some cases money is conserved (double entry booking), in others money behaves more like a Banach-Tarski ball (think bank money multipliers).
Neo-classical capitalism doesn't even acknowledge the laws of nature let alone follow them.
Jeremy Rifkin has written a lot of about this topic and his arguments that economists should first learn the laws of thermodynamics before being set loose on the economy.
Inflation would mean that also people need to get more money. Currently, inflation is at 2%, but wages stay the same, as wages are coupled to economic growth usually. So only those who already were rich before profit from the current situation – while originally, inflation was meant to prevent people from hoarding money.
I think the thing that people have the most trouble with is assessing the "objectivity" of the arbiter that controls the money supply ("the fed) and at least the "perception" that fed actions benefit those that haven't done anything to gain such preferential treatment.
>Most central banks dictate that there should be 2% inflation, which means the economy needs to grow 2% per year.
That's not true. Inflation isn't directly tied to growth. The Fed attempts to make inflation 2% no matter what the economy grows. 2% growth might cause 2% inflation, but if there was 5% growth, the fed would reduce money supply to keep inflation around 3%.
And during no growth, the fed could increase money supply to ensure inflation during recessions. And that is in fact what they did during the great recession.
Thomas Palley [1] sums this up nicely in a 2011 critique of QE:
The underlying problem is structurally deficient demand caused by thirty years of neoliberal economic policies that have undermined the income and demand generation process (Palley, 2009). However, rather than fixing this problem, policymakers are again turning to ultra-easy monetary policy in the form of QE. Viewed from this perspective, QE can be interpreted as a form of asset market trickledown whereby supporting asset prices is supposed to jumpstart the macro economy…From a political standpoint, this is an enormous change from the world of forty years ago. The New Deal policy paradigm of wage floors and household income supports has been replaced by one of asset price floors and asset market subsidies. Viewed through a political lens QE therefore represents the triumph of plutonomics, and that makes it an obstruction to the extent it obscures the challenge of repairing the income and demand generation process.
The Fed has dug itself into a hole with QE, where it is losing the ability to control anything in the economy due to the lower 0 bound of the FFR and the economy's inability to handle an interest rate hike.
It is up to the Federal Government (which, democratically speaking, means we the people) to adopt New Deal-like investments in infrastructure, R&D, education, and tech to seed long-term prosperity in order to rebuild an economy with a strong middle class that will demand loans for things like mortgages, appliances, cars, and machinery, as well as drive invention and wealth creation rather than rent-seeking & arbitrage as we are seeing today.
[1] https://ideas.repec.org/p/uma/periwp/wp252.html