Pethokoukis, Economics, U.S. Economy

Columnist confusion about the Fed, QE and Janet Yellen

Image Credit: International Monetary Fund (Flickr) CC

Image Credit: International Monetary Fund (Flickr) CC

George Will, normally one of my favorite colunmists, writes another column about the Federal Reserve and again misses the mark. This gets at the gist of his worries about a Fed led by Janet Yellen:

She probably will continue, perhaps even longer than the departing Ben Bernanke would, the “quantitative easing” that is “trickle-down economics” as practiced by progressives:

Very low interest rates drive investors into equities in search of higher yields. This supposedly produces a “wealth effect” whereby the 10 percent of Americans who own about 80 percent of stocks will feel flush enough to spend and invest, causing prosperity to trickle down to the other 90 percent. The fact that the recovery, now in its fifth year, is still limping in spite of quantitative easing is, of course, considered proof of the need for more such medicine.

Easing serves two Obama goals. It enables the growth of government by deferring its costs with cheap borrowing. And it redistributes wealth: By punishing savers, it effectively transfers wealth from them to borrowers. .. The Fed seems to be evolving into a central economic planner with a roving commission to right social wrongs such as unemployment.

1.) What is the counterfactual? What would the US economy look like today if the Fed were neither buying bonds nor promising keep the federal funds rate very low for a very long time? What would it look like with the tight money Will apparently wants?

Well, we have the natural experiment of two advanced economies that have both been practicing fiscal austerity: the euro zone (passive central bank, double-double digit unemployment, double-dip recession, looming deflation) and the US (active central bank, falling unemployment, slow economic growth) but with very different results.

2.) If you are looking for something more mathematical, there is this scary QE counterfactual from Political Calculations. According to PC’s model, the fiscal drag from spending cuts and tax hikes should have put the US economy into a deep recession this year. Instead of nominal GDP rising by 2% from late 2012 through the first half of this year, it would have fallen by 2%.  So the Fed efforts may well have prevented a double-dip recession of the sort Europe (and the stand-pat ECB) has experienced where unemployment is over 12%. In the US, the U-3 jobless rate might have made a return trip back near 10%.

Noting the 2012 US economy seems no better than the 2013 US economy misses this counterfactual.

3.) Is the Fed exacerbating income inequality as Will suggests? Here is JPMorgan economist Michael Feroli on why it is not – particularly when income is measured as disposable income:

 … the well-off earn more interest income than average, and pay less interest expense than average, and so their disposable income is relatively harmed by lower interest rates. The converse holds true for lower-income households. The second reason is that as an empirical matter wage inequality is reduced when the economy is operating closer to full employment. To the extent Fed policy has been stimulating economic activity and closing the output gap, it is serving to narrow wage disparities—or at least offset other longer-run forces that have been contributing the growing wage inequality.

4.) And as for Will’s point about punishing savers with low interest rates … well, I will let Scott Sumner handle this one:

– Tight money does not raise interest rates, at least over the relevant time frame for welfare considerations.  Interest rates in the eurozone today (0.5%) are almost certainly lower than they would have been had the ECB not adopted a tight money policy in 2011, raising rates from 0.75% to 1.25%.  That policy drove the eurozone deeper into recession, pushing rates even lower. The same thing happened in America in 1937-40.  That’s right, low rates can reflect tight money.  Even low real rates.  The low real rates in America today partly reflect the recent recession, which was caused by ultra-tight monetary policy in 2008-09.

– Tight money hurts saving nations in other ways.  For instance, the ECB policy that caused eurozone NGDP to grow by 2.7% over the past 5 years (instead of the normal 22%), has dramatically worsened the sovereign debt crisis.  As a result of this crisis, savers and taxpayers in high saving countries like Germany will suffer enormous losses.

– Thus the central bank should not help virtuous savers, nor should it try to help non-virtuous savers.  But the tax authorities should help both groups, by eliminating all taxes on investment income.

5.) I  can hardly believe that Will seems still to be unaware of the market monetarist take on Fed policy, especially since he is familiar with Milton Friedman monetarism. In fact, I don’t believe it. Look, the Fed should try and provide nominal stability, while fiscal policy focuses on supply-side factors. Is this central planning? Is Will proposing to end the Fed? If not, then the goal should be to figure out the best way the Fed should conduct monetary policy given Hayekian knowledge limits. Economist John Hendrickson:

 …  the question is what a central bank should do given that one exists.  I favor nominal income targeting because (1) I think that it minimizes the information and knowledge that central bankers must have to do their job and (2) because a nominal income target requires the money supply to adjust roughly in the same way as it would under a free banking system.  In other words, a nominal income target is as close as we can get a central bank to replicating what would happen if we had a free market for bank notes. To argue that the Fed shouldn’t conduct QE because centrally planning is hard is an argument against a central bank, it is not an argument against QE.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.

11 thoughts on “Columnist confusion about the Fed, QE and Janet Yellen

  1. She probably will continue, perhaps even longer than the departing Ben Bernanke would, the “quantitative easing” that is “trickle-down economics” as practiced by progressives“…

    Ahhh, so progressives think that monopoly money can be used in lieu real money, eh?…

    Dagong Downgrades the U.S. Sovereign Credit Ratings to A-

    On October 16, 2013 EST, the U.S. Congress approves the resolution to end the partial government shutdown and raise the debt ceiling. By such means the U.S. Federal Government can avoid the default crisis for the moment. However the fundamental situation that the debt growth rate significantly outpaces that of fiscal income and GDP remains unchanged. For a long time the U.S. government maintains its solvency by repaying its old debts through raising new debts, which constantly aggravates the vulnerability of the federal government’s solvency

  2. If it only low interest rates were punishing the affluent alone. There are literally millions of retirees who won’t buy stocks on a bet and who limp along with CDs at rates that won’t cover pet food.

    And I for one would be grateful if the blogger curbed the use of models to “prove” QE put us in a better place than we would have been. Could be it’s the real estate recovery lifting economy (with an assist from the Fed.) Could be the models are wrong.

  3. So in order to provide retirees with guaranteed income, Todd, you’d redistribute even more wealth from the Millennials by way of forcing us to pay more interest on the student loan debt a vast majority of us have?

    • No. 1, investment income isn’t guaranteed. With the best 5-year jumbo CD rate at 2 percent, far from it.
      No. 2, the transfer of wealth in this case is from old to young. (Your lender gives you a great deal on student loans because geezers are getting a raw deal.)
      No. 3. There’s no net redistribution in SS either. Yet. FICA collections plus interest on SS’s $3 trillion surplus will make the nut through 2020 give or take.

      You want to be upset with someone, pick Dubya, who decided that the Koch brothers needed tax relief first and he’d get around to fixing SS for young workers later.

      • 7 percent interest is “a great deal”? How about zero percent interest, because without an educated population, there won’t be anyone working to pay for those future Social Security benefits? How about retroactively canceling all student loans?

        I don’t care that CDs don’t earn anything. Nobody is entitled to make a living by doing nothing more than stuffing money in a bank account.

        • Dunno how or why you pay 7 percent but the current federal rate is 3.86 percent, which, in fact, is cheap money.

          And the geezers getting screwed are not moneybags types, but ordinary folks who skrimped and saved over a lifetime, I am tempted to succumb to Millennial stereotypes here but will simply say that you’d be surprised at how much money a frugal person can accumulate in a lifetime.

  4. I am far from qualified to judge the advantages and disadvantages of active versus passive fiscal policy as practiced by the Fed and by the ECB. However, if the Federal Reserve adjusts bank interest rates in reaction to rising and falling inflation and if the ECB is controlling through secondary bond market transactions in reaction to changing debt ratios – both methods would be reactionary, thus active, methods.

    The challenge at the ECB appears to be finding the best way to keep the social push toward more from the government, under any economic trend, in check with 13 or so separate entities and one currency.

    QE at the Fed, it seems to me, would be on the extreme edge since it is a 180 degree turn from interest rate setting – but that may be because setting negative interest rates would be inappropriate.

  5. “Easing serves two Obama goals. It enables the growth of government by deferring its costs with cheap borrowing. And it redistributes wealth: By punishing savers, it effectively transfers wealth from them to borrowers.”

    Who is borrowing? I thought the banks are holding onto the QE $$$ in reserves? Appreciate feedback

  6. First, George Will should read Milton Friedman’s seminal piece on QE, before he (Will) writes another word: Please George Will, love you and read this:

    There you have Friedman, writing for the Hoover Institution, that QE is what Japan needs, the more the better.

    If that is not conservative credentials, then I do not know what is.

    Then, consider that any federal policy—from defense, the agriculture, to foreign relations to the tax code—will have some winners and losers.

    If Market Monetarism is shelved as some groups might benefit…then let’s shelve defense too, as people in defense industries directly benefit, or rid ourselves of the home mortgage interest tax deduction….why not kill the concept of money, as it only helps bankers, and we can go back to barter….

    Back in the real world, I think by stimulating demand, and thus demand for workers, QE will help the “lower-class” as much as anybody. Tight labor markets seem to shift income to labor. Duh.

    GIve unto me a growing, prosperous economy, I want to see Fat City again. Boom times baby.

    The Fed is asphyxiating America. That is the real story. The ECB is doing the same thing to Europe.

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