The Threat of QE2

As Tom Clougherty reports, I have written a think piece for the Adam Smith Institute on QE2. I wrote the article quite quickly, and was not being false modest when I say:

I don’t intend to settle this debate – declaring it ‘right’ or ‘wrong’ oversimplifies what is a complex issue.

I've read a host of articles on QE2 and I do think that there's too much knee-jerking and reliance on priors. To be sure the use of QE to boost aggregate demand (rather than prevent a liquidity meltdown) is a precedent, and precedents require theological arguments*, but let's not be glib here.

I call to task economists that have continually warned of hyperinflation since the first round of QE (myself included), but I also try to make a distinction between the monetary disequilibrium approach and monetary accomodation:

There is a plausible free market argument to say that under certain institutional conditions (such as competitive banks and no moral hazard), increases in the money supply to offset changes in the demand for money would avoid adjustments having to take place through the notoriously ‘sticky’ real economy. In the same way that inflation creates real effects, so does a monetary deflation, and these effects are neither desirable nor necessary. However, whether this theoretical possibility can be acted upon is another matter. Even if central bankers had the benevolence to try to replicate markets, they most certainly do not possess the omniscience. Expecting such economists to comment on the ‘appropriate’ level of monetary expansion misunderstands the whole point.

In other words - Pete Boettke are you listening (!) - there is a very clear dividing line between Austrian "free bankers" and Scott Sumner-type monetarists (see comments sections here and here).

* 2006 “ The Spread of Economic Theology: The Flat Tax” Romanian Economic and Business Review Vol. 1 No. 1 pp.41-53

Update: Chris Dillow discussed my article:

Anthony is bang right to say that you cannot buy confidence.
I quibble on just one point. Anthony says that QE increases regime uncertainty. He’s probably right. But I’m not sure it increases overall uncertainty. In the absence of QE, we’d still be uncertain about whether confidence will return and how fast the real adjustments (away from debt and construction) in the economy will take place. QE doesn’t add to this uncertainty, so much as displace a little of it; there‘s more uncertainty about policy, but less about the real economy, to the extent that the risk of a catastrophe is diminished.

If I suggested that QE increases overall uncertainty then I take it back. I consider myself one of the very few economists that takes notions of uncertainty seriously, and I simply do not believe that uncertainty exists in an aggregate form. In the same was that there's no such thing as "risk aversion" (merely "aversion to certain types of risk"), you cannot "reduce" risk - you can only move it about. And if statements such as "banks decided to take on too much risk" are meaningless, the idea that certain policies increase or reduce uncertainty in an aggregate sense are nonsense. As Chris makes clear - policies can only alter types of risk and uncertainty, and policies can only displace it.

Comments

[Current]

As you would expect I agree with your article on almost every point. I'm happy that you're emphasising the regime uncertainty problems and the "tightrope" that central banks face, I think some of the other monetary equilibrium economists have been glossing over that.

There is one small exception though which is worth noting. The US isn't the same as Britain. Britain has an inflation target the US have some wishy-washy laws that call for the Fed to pay attention to both price stability and unemployment. This makes the Fed's position trickier than the BoE's. Certainly the BoE has to take some notice of unemployment and output, but it can take much less notice than the Fed.

That makes things a bit more predictable in Britain than they are in the US. It also makes the pronouncements of the central bankers a bit less significant. Their significance in the US is that they indicate whether the Fed is going to pursue the unemployment mandate or the price stability mandate more strongly. For example, if the economy is heading back into recession (as the US seems to be) then is the central banker says something about being aware of the threat of inflation then that's a signal to the market that he will follow the price mandate more thoroughly and allow employment to fall rather than performing heroic quantitative easing. If he says something about the threat of deflation or unemployment then this is the situation where monetary policy becomes much less powerful than normal, because it's known by the market that though the Fed can temporarily inflate they must pull back later.

In Britain the problem still exists because we have an inflation target not a longer-run price level target or NGDP target. I think that in Britain the uncertainty problem is a bit less significantly than it is in the US.

[Current]

I think that central banks can generate uncertainty. If they are unclear about future monetary policy then marginal future plans that depend for their profitability on the price level cannot be made. It's not that QE per se creates regime uncertainty. It's that it foster a situation where the future price level becomes less clear because of doubts over the central banks intentions and the political and technical problems of withdrawing the base afterwards. It places the central bank on that tightrope you discussed.

[MBT Shoes]

It's so nice to have you do all of the research for us. It makes our decision making so much easier!! Thanks.