The Filter^

The emerging view on QE2

Further to my article on QE2, I've read some good articles on the subject.

Raghu Rajana offers a measured overview:

Clearly, the Fed’s objective is to increase bond prices, in the hope that lower long-term interest rates will propel corporate investment. In addition, the Fed hopes that lower long-term interest rates will push up asset prices, giving households more wealth and greater incentive to spend. Finally, by demonstrating a willingness to print money, the Fed hopes to increase inflationary expectations from their current low levels.

In the FT Martin Fieldstein provides a nice intro:

Under the label of QE, the Fed will buy long-term government bonds, perhaps one trillion dollars or more, adding an equal amount of cash to the economy and to banks’ excess reserves. Expectation of this has lowered long-term interest rates, depressed the dollar’s international value, bid up the price of commodities and farm land and raised share prices.

Mr Bernanke’s argument for QE is based on the “portfolio balance” theory which stresses that, when the Fed buys bonds, investors increase their demand for other assets, particularly equities, raising their price and increasing household wealth and spending.

He goes on to list several downside risks:

• Like all bubbles, these exaggerated increases can rapidly reverse when interest rates return to normal levels 
• The lower US interest rates are causing a substantial capital flow to those economies, creating currency volatility. The economies hurt by the increasing value of their currencies are responding with measures to protect their exports and limit their imports, measures that could lead to trade conflict 
• the increased cash on banks’ balance sheets will make the Fed’s exit strategy harder

Even better, writing in Prospect, Faisal Islam writes a fantastic essay trying to assess the impact of QE1. I'll provide some commentary. Firstly, I wasn't the only person paying attention to Willem Buiter - in short ideas matter:

David Cameron’s response was more measured. I met him at that time and he seemed to have recently mugged up on advanced monetary economics. He referenced economist Willem Buiter’s blog in depth and regaled me with his knowledge of the difference between quantitative easing (the sheer amount of buying the central bank could do) and qualitative easing (an attempt to lower interest rates in specific markets, such as mortgage debt and corporate credit).

Islam provides a nice account of the actual provess by which QE operates:

On any given morning the debt management office (DMO), an arm of the treasury, sold billions of pounds worth of British gilts to the world. Then in the afternoon, barely 400 metres away, the Bank held a reverse auction where it, in effect, bought up billions of similar government debts. Under EU rules it would have been illegal for the DMO and the Bank to trade with one another. So instead the City stepped in, making profits on trading both sides of this  bizarre monetary merry-go-round for over a year.

As I said on the day after it launched,

Although we are not monetising the government debt in the same way that Zimbabwe has, it is hard to make any clear distinction. Yes, the Bank of England is purchasing assets on the secondary market (not directly from the Treasury). Yes, the Bank has every intention to mop up this additional liquidity once the economy recovers, but "directness" and "intentions" are largely semantic.

The head of the DMO does little to deny this:

“On the other hand, we must make the distinction—we are raising money by selling new gilts but the Bank is buying old gilts in the secondary market.”

In my assesment of QE1 I tried to identify the winners,

banks have benefited. QE served as a bailout by the back door

Islam adds more detail:

"It’s not to say that what the Bank [of England] is doing is useless—it has helped the banks, but it doesn’t inject new money. That is only injected when the money leaves the banking sector and goes into the economy. So far the money has just been passed from central banks to commercial banks,”

Indeed:

Winners from QE include the City trading desks that saw the value of their bond portfolios soar. Other beneficiaries include the sovereign bond dealers who passed bonds from the DMO to the Bank at almost no risk, and the commercial banks who gained a supportive source of free funding.

The losers, on the other hand:

director general of Saga, Ros Altmann, says: “QE is the worst thing that could happen to pensions, it is devaluing and destroying pensioners’ income.”

Islam interviews Alistair Darling for the article, and although you'd have thought Darling might have made this point before authorising £200bn of spending, he says (remarkably candidly):

We need a treasury and Bank of England evaluation as to where it is. Is it in circulation, or sitting in bank vaults?”

Audit the Bank? Here here.

The article also gives a lot of attention to the notion of NGDP targetting

“The Bank needs to set a nominal GDP growth target,” he [Richard Werner] says. A nominal GDP target incorporates a bit of inflation and a bit of growth in one target

Wener is the economist who coined "quantitative easing" to argue that Japanese policy was not radical. A further argument that Austrian's might be interested in, is the distinction between an expansion in the money supply to offset an increase in the demand for money, and an expansion in the money supply as a means to stimulate aggregage demand. According to Simon Ward:

“QE1 wasn’t inflationary, it was antideflationary, but QE2 would be very dangerous, because there is no shortage of liquidity and the banking system is stronger.”

Finally, as I keep trying to point out we are yet to solve the underlying problems that caused the crisis - and if we learn one lesson from Japan it should be that zombie banks are not conducive to monetary nor fiscal stimuli. Danny Gabay's thoughts on this are interesting:

He contends the failure to cleanse Japan’s bank balance sheets of zombie property companies (insolvent companies kept afloat by the banks) caused its lost decade. Zombie households with large debts and overvalued property is the British equivalent. QE could be used to buy up houses at a discount, jump-starting a stalled property market.

I'd argue that house prices need to drop, and policy should be directed towards how this might happen without consigning millinos to a lifetime of debt, but the bottom line needs to be bank restructuring. I don't think we can see a recovery until some banks go bankrupt.

The sound money proposal

Last night I gave a talk at the Libertarian Alliance (I believe the video will shortly appear here). The proposal is: “2 Days, 2 Weeks, 2 Months" (also see my comments here). There was a good discussion afterwards, and I was rightly put to task for identifying deposit insurance as a key problem. Indeed when I talk about deposit insurance, I am implicitly referring to taxpayer funded deposit insurance. There is nothing wrong at all with private deposit insurance, and indeed note that the Financial Services Compensation Scheme is industry (not government) funded.

But this brings up a curious possibility - recollect that 100% reserve advocates often claim that banking and insurance are not comparable, because whilst the former abuses it's creditors that latter do not. So what if, instead of offering a 100% reserve account with a storage fee a bank offers a slightly less than 100% reserve account with a fee for deposit insurance? Wouldn't this satisfy the argument that such desposits need to be "safe"? And by definition this is an insurance, and not a banking product. I don't know the answer, but it's these sorts of innovation that make it very difficult to prescribe particular forms of banking.

Another interesting topic during the Q&A was the strategy for reforms. My plan is written to be a set of guidelines that could be followed when the next banking crisis hits. To be sure, we can't just sit back and think that if we have an alternative it will even be considered, let alone used. Hence the importance of the Carswell Bill, which seeks to solve the problems within banking from where we stand today. I did raise the possibility, however, that a public debate would reduce the chances of radical reform.

Think of the difference between how Estonia and the Czech Republic adopted the flat tax - my own work* suggests that when you have a Prime Minister who's only read one economics book in his life, uncertainty about the right policy solution, and a void of debate - radical solutions become possible. With a large civil society you run the risk that the economically ill informed media majority corrupt that debate and spread ignorance. We know that people's priors tend to favour regulation over freedom - whilst I am a public intellectual and seek to debate economics on as wide a platform as posible, I am a realist in the sense that giving ideas an airing doesn't automatically lead to greater acceptance.

* 2008 “The Spread of the Flat Tax in Eastern Europe: A Comparative Study” (with Paul Dragos Aligica) Eastern European Economics Vol. 46 No. 3 pp. 55-74  *

2010 Liberty Lectures

Back in August I gave a talk at the Adam Smith Institute's "Liberty Lectures", held at Cass Business School. I was very impressed with both the concept and organisation, and the turnout was fantastic. 

Here's what Charlie Edwards had to say:

Anthony J Evans, ... , likened the economic cycle to a night out. The inflationary ‘boom’ is the good part of the night, drinks are flowing, perhaps more than you can handle. When it does become too much to handle, you chunder.

Fortuitously Nikolai Wenzel arrived at St Pancras that afternoon and was able to attend (if you look closely you might spot us both in the photo above).

Update: I held off posting this until the video was out, but it seems to be taking a long time so I'll publish anyway.

How to Prevent a Currency War - Project Syndicate

the experience of the 1930’s suggests that exchange-rate disputes can be even more dangerous than deep slumps in terms of generating protectionist pressures.

via www.project-syndicate.org

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.

Cobden Centre Radio: Dr. Anthony J. Evans on Austrianism’s return home to Europe » The Cobden Centre

Brian Micklethwait continues his ongoing mission ... by speaking to one of its foremost practitioners in England, Anthony J. Evans, who is Assistant Professor of Economics at ESCP Europe, co-author of The Neoliberal Revolution in Eastern Europe: Economic Ideas in the Transition from Communism, and a founding fellow of the Cobden Centre.

via www.cobdencentre.org

Further to my recent talk on the rise of Austrian economics (I believe we can label it "the second revival"), see above for a recent interview with Brian MIcklethwaite. This one was more biographical, and if memory serves the key points I was trying to get across was the importance of an Austrian PhD program for the UK.

The MP3 is here.

Update: I've just listened to the interview and there's a part where I say "post-Keynesian" when I really mean "New Keynesian". I'd been reading Dave Prycitko's article on the train in, but the error should be obvious. Also, the audio cut out when I mentioned "The Capitalist Alternative". Here's a link.

Quote of the week

"To Austrians inflation never stabilises, it is always destabilising"

Mark Skousen, speaking at the IEA

FT.com / Markets - Traders on alert as G20 finance ministers meet

Another example of regime uncertainty:

Trading is somewhat subdued across financial centres as investors appear a bit reluctant to take fresh positions ahead of this weekend’s conclusion of the G20 finance ministers meeting in Seoul at which forex policy will be centre stage.

via www.ft.com

Prychitko on the Minsky moment - an example of the epistemic primacy hypothesis?

I've just read David Prychitko's article assessing the financial instability hyposthesis from an Austrian perspective. It is in the current issue of the Review of Austrian Economics (a first class edition, I must say...), and I've also noticed (via Steve Horwitz) that not only has Peter Lewin shared his thoughts, but that Peter Lewin is blogging (this is fantastic!)

I really enjoyed the article, which argues that the "Minsky moment" can be viewed as one phase of the overall Austrian business cycle story, one that is already explained by the ABC, and one that fails to provide for an account of the overall cycle. In short, we can learn from it and shouldn't ignore the insights, but it's neither a full blown alternative not refutation.

The part I found most interesting was when Prychitko discussed the Greenspan put (p.219). I confess that this is normally a red flag to me, indicating that someone is using traditional Public Choice-style incentive arguments and not distinctly Austrian attention to knowledge problems. I am a big fan of Jeff Friedman on this point (and have a working paper with him), and have a paper under review that spells this out in more detail (email me for a copy - it's based on talks at the 2008 Southerns and the FEE conference on Vienna to Virginia). My problem is those who downplay the differences between the Austrian and Public Choice approaches, settling for the idea that both matter. The problem is that in many empirical examples these offer two alternative hypotheses. My concern is that the similarity between the conclusions between the two schools lead people to downplay the analytical differences.

My understanding of the "epistemic primacy thesis" (previously alluded to here) is the following:

epistemic factors take primacy over motivational ones

I follow Lavoie (1985) in treating the "problem of knowledge" as more fundamental to the "problem of motivation", and Kirzner's view that:

“unless one could imagine that Mises’ calculation problem has somehow been solved, questions of motivation… cannot even be asked” (Kirzner 2006, 30).

(Incidently, I view Chris Coyne's "After War" as a classic example of taking epistemic primacy seriously.) In terms of the financial crisis, I therefore think that people who advocate moral hazard explanations are typically not taking knowledge problems seriously. And indeed when I re-read Prychitko on this it became clear that he's using the Greenspan put as an example of the consequences of the conditions of uncertainty and ignorance. In this sense we do indeed see knowledge problems being treated as primary to incentive ones. Maybe I should re read other articles to see if they do possess this subtlety, but it's something that leaps from the page.

I appreciate that this sort of claim is best tested within the peer review process, but given the public debate of Prychitko's article (and the fact I happened to read it today), I wanted to make this small contribution.

Hayek vs. Keynes at Buttonwood

Note Mervyn King in the audience! A couple of times in the last month students have sent me the original rap video unaware that I'm a student of Russ Roberts. I'm confident that this video will be seen as a major cause of the second revival in Austrian economics.