The Good News and the (Very) Bad News about Bernanke’s Speech

UPDATE:  In response to a comment, I have revised slightly the third paragraph of this post to remove an unnecessarily harsh rhetorical attack on Mr. Bernanke.

Ben Bernanke gave his commentary about US monetary policy at the annual late summer monetary conference at Jackson Hole, Wyoming sponsored by the Federal Reserve Bank of Kansas City. At the 2010 meeting, just after the stock market had fallen by nearly in the month of August as fears of potential deflation were rapidly gathering strength, Bernanke signaled that the FOMC would undertake its second round of quantitative easing, prompting a quick turnaround in both inflation expectations and the stock market. The rally in inflation expectations and the stock market continued impressively from September through February when a series of adverse supply shocks, the loss of Libyan oil supplies after the uprising against Colonel Gaddafi’s regime, the earthquake, tsunami, and nuclear meltdowin in Japan, put a damper on the modest expansion that was getting underway. A similar downward drift of inflation expectations this spring led to a substantial drop in stock prices from their early 2012 highs, prompting Bernanke and the FOMC to emit faint signals that a third round of quantitative easing just might be in the offing at some future time if it seemed warranted. Those signals were enough to reverse a months long downward trend in inflation expectations producing a rebound in stock prices back close to their highs for 2012.

So the good news from Bernanke’s speech is that he argued that, contrary to those who deny that monetary policy can be effective at the zero lower bound, there is empirical evidence showing that the previous rounds of quantitative easing had a modest stimulative effect. Bernanke maintains that quantitative easing has increased GDP by 3% and private payroll employment by 2 million jobs compared to a scenario with no QE. That Bernanke went to the trouble of making the case that previous rounds of QE have been effective suggests strongly that Bernanke has decided that the time has come to try one more round of QE, notwithstanding the opposition of some members of the FOMC, like Richard Fisher of the Dallas Fed, and among the other regional Federal Reserve Bank Presidents, notably Jeffrey Lacker of the Richmond Fed and Charles Plosser of the Philadelphia Fed. That’s the good news.

Now for the bad news — the very bad news – which is that the arguments he makes for the effectiveness of QE show that Bernanke is totally clueless about how QE could be effective. If Bernanke thinks that QE can only work through the channels he discusses in his speech, then that gives us a very acute insight into why the Fed, under Bernanke’s watch, has failed so completely to bring about a decent recovery from the Little Depression in which we have been stuck since 2008.  Consider how Bernanke explains the way that the composition of the Fed’s balance sheet can affect economic activity.

In using the Federal Reserve’s balance sheet as a tool for achieving its mandated objectives of maximum employment and price stability, the FOMC has focused on the acquisition of longer-term securities–specifically, Treasury and agency securities, which are the principal types of securities that the Federal Reserve is permitted to buy under the Federal Reserve Act.  One mechanism through which such purchases are believed to affect the economy is the so-called portfolio balance channel, which is based on the ideas of a number of well-known monetary economists, including James Tobin, Milton Friedman, Franco Modigliani, Karl Brunner, and Allan Meltzer. The key premise underlying this channel is that, for a variety of reasons, different classes of financial assets are not perfect substitutes in investors’ portfolios.  For example, some institutional investors face regulatory restrictions on the types of securities they can hold, retail investors may be reluctant to hold certain types of assets because of high transactions or information costs, and some assets have risk characteristics that are difficult or costly to hedge.

Imperfect substitutability of assets implies that changes in the supplies of various assets available to private investors may affect the prices and yields of those assets. Thus, Federal Reserve purchases of mortgage-backed securities (MBS), for example, should raise the prices and lower the yields of those securities; moreover, as investors rebalance their portfolios by replacing the MBS sold to the Federal Reserve with other assets, the prices of the assets they buy should rise and their yields decline as well. Declining yields and rising asset prices ease overall financial conditions and stimulate economic activity through channels similar to those for conventional monetary policy.

Bernanke seems to think that changing the amount of MBSs available to the public can alter their prices and change the shape of the yield curve. That is absurd. The long-term assets whose supply the Fed is controlling are but a tiny sliver of the overall stock of assets whose prices adjust to maintain overall capital market equilibrium Affecting the market for a particular group of assets in which it is trading actively cannot force all the other asset markets to adjust accordingly unless the Fed is able to affect either expectations of future real rates or future inflation rates. If the Fed has succeeded in driving down the yields on long term assets, it is because the Fed has driven down expectations of future inflation or has caused expectations of future real rates to fall. The balance-sheet effect can at most affect the premium or discount of particular securities relative to other similar securities.  If I am in a position to change the price of crude oil at Cushing Oklahoma, it does not mean that I can control the price of crude throughout the entire world.  Bernanke continues:

Large-scale asset purchases can influence financial conditions and the broader economy through other channels as well. For instance, they can signal that the central bank intends to pursue a persistently more accommodative policy stance than previously thought, thereby lowering investors’ expectations for the future path of the federal funds rate and putting additional downward pressure on long-term interest rates, particularly in real terms. Such signaling can also increase household and business confidence by helping to diminish concerns about “tail” risks such as deflation.

Bernanke is on to something here, but he is still not making sense. What does Bernanke mean by “a more accommodative policy stance?” The policy stance of the central bank does not exist in isolation, it exists in relation to and in the context of the state of the real economy. Thus, any signal by the central bank about the future path of the federal funds rate is ambiguous insofar as it reflects both a signal about the central bank’s assessment of the public’s demand for accommodation and the central bank’s supply of accommodation conditional on that assessment. When the central bank announces that its lending rate will remain close to zero for another year, that doesn’t mean that the central bank is planning to adopt a more accommodative policy stance unless the central bank provides other signals about what its assessment of, or target for, the economy is.  The only way to provide such a signal would be to announce a higher target for inflation or for NGDP, thus providing a context within which its lending rate can be meaningfully interpreted.  And a signal that increases household and business confidence by diminishing concerns about deflation should not be associated with falling nominal interest rates and falling inflation expectations — precisely the result that Bernanke feels that earlier rounds of QE have accomplished. Actually, the initial success of QE2 was associated with rising long-term rates and rising inflation expectations. It was only when the program petered out, after adverse supply shocks caused a temporary blip in commodity prices and CPI inflation in the spring of 2011, that real interest rates and inflation expectations began to drift downwards again.

Because he completely misunderstands how QE might have provided a stimulus to economic activity, Bernanke completely misreads the evidence on the effects of QE.

[S]tudies have found that the $1.7 trillion in purchases of Treasury and agency securities under the first LSAP [large-scale asset purchases] program reduced the yield on 10-year Treasury securities by between 40 and 110 basis points. The $600 billion in Treasury purchases under the second LSAP program has been credited with lowering 10-year yields by an additional 15 to 45 basis points.  Three studies considering the cumulative influence of all the Federal Reserve’s asset purchases, including those made under the MEP, found total effects between 80 and 120 basis points on the 10-year Treasury yield.  These effects are economically meaningful.

The reductions in long-term interest rates reflect not the success of QE, but its failure. Why was QE a failure? Because the only way in which QE could have provided an economic stimulus was by increasing total spending (nominal GDP) which would have meant rising prices that would have called forth an increase in output. The combination of rising prices and rising output would have caused expected real yields and expected inflation to rise, thereby driving nominal interest rates up, not down. The success of QE would have been measured by the extent to which it would have produced rising, not falling, interest rates.

Bernanke makes this fatal misunderstanding explicit later on in his speech.

A second potential cost of additional securities purchases is that substantial further expansions of the balance sheet could reduce public confidence in the Fed’s ability to exit smoothly from its accommodative policies at the appropriate time. Even if unjustified, such a reduction in confidence might increase the risk of a costly unanchoring of inflation expectations, leading in turn to financial and economic instability. It is noteworthy, however, that the expansion of the balance sheet to date has not materially affected inflation expectations, likely in part because of the great emphasis the Federal Reserve has placed on developing tools to ensure that we can normalize monetary policy when appropriate, even if our securities holdings remain large. In particular, the FOMC will be able to put upward pressure on short-term interest rates by raising the interest rate it pays banks for reserves they hold at the Fed. Upward pressure on rates can also be achieved by using reserve-draining tools or by selling securities from the Federal Reserve’s portfolio, thus reversing the effects achieved by LSAPs. The FOMC has spent considerable effort planning and testing our exit strategy and will act decisively to execute it at the appropriate time.

Bernanke views the risk of an unanchoring of inflation expectations as a major cost of undertaking QE. Nevertheless, he exudes self-satisfaction that the expansion of the Fed’s balance sheet over which he has presided “has not materially affected inflation expectations.” OMG!  The only possible way by which QE could have provided any stimulus to the economy was precisely what Bernanke was trying to stop from happening. Has there ever been a more blatant admission of self-inflicted failure?

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35 Responses to “The Good News and the (Very) Bad News about Bernanke’s Speech”


  1. 1 Russ Abbott September 2, 2012 at 10:08 pm

    I have a better, simpler, and more direct way for the Fed to stimulate the economy. Give it the authority to add a rebate to all commercial transactions. That would “put the economy on sale” and encourage demand. It would not produce inflation (at least not directly) because it would lower prices rather than raise them. (The complementary authority, i.e., to add a surcharge, could be used when inflation threatens.)

    Such an authority would require new legislation and additional mechanisms. But we are sophisticated enough to handle those.

    This approach would be immediate and direct. it would also be simple enough for everyone to understand. We should try it.

  2. 2 Benjamin Cole September 3, 2012 at 2:22 am

    In general, I agree with everything said in this very thoughtful post.

    I do wonder about this statement by Bernanke:

    “A second potential cost of additional securities purchases is that substantial further expansions of the balance sheet could reduce public confidence in the Fed’s ability to exit smoothly from its accommodative policies at the appropriate time. Even if unjustified, such a reduction in confidence might increase the risk of a costly unanchoring of inflation expectations, leading in turn to financial and economic instability.”

    Really, what fraction of the public could even pick Bernanke out of a line-up, or having accomplished that, even tell you what is QE, let alone the level of it, and the Fed balance sheet? (This is not to say the public is stupid; a very smart chemist probably doesn’t know what is QE.)

    But people who sell bonds to the Fed will spend the money or invest it in other assets, all good.

    Further, I think there is a good chance the Fed is going to have to get used to growing balance sheets. If the 20-year secular and global downtrend in interest rates is sustained at all, then the “conventional” central bank weapon for stimulus—lower interest rates—becomes as useful as a firehose against a flood.

    Whatever one’s politics or agenda, the default stimulus is QE. Or perma-recession.

    I sense that central banks will have to become founts of money for national governments, by forwarding interest earned on assets.

    I share the concern of nearly anybody who is aware of how Congress and the White House like to spend money and hand out tax breaks.

    Yet, if total federal spending can be limited o a fraction of GDP, we may actually be seeing a wonderful epoch ahead of lower tax rates and monetary stimulus via QE.

  3. 3 Julian Janssen September 3, 2012 at 6:15 am

    David,

    A very good post (which even got the attention of Brad DeLong). I have always thought that Bernanke was basically an economist’s economist, but, alas… You caught him in some very bad absurdities.

    Frankly I think his position on forward guidance on policy is completely inconsistent with his position that the Fed is prepared to stop and reverse course in order to stave off inflation. But isn’t that the core of the idea of forward guidance: to commit to the policy of accommodation, bringing a burst of higher than “normal” inflation for a bit? Maybe the Fed can commit to non-contradictory goals. I am beginning to strongly favor monetary policy which is only partially forward-looking (like NGDPLT or something similar). Why doesn’t the Fed just adopt it for a while, so they can signal a desire to have a short period of above-average inflation followed by policy intended to normalize inflation…

  4. 4 Pablo September 3, 2012 at 6:39 am

    when you say that: “Because the only way in which QE could have provided an economic stimulus was by increasing total spending (nominal GDP) which would have meant rising prices that would have called forth an increase in output. The combination of rising prices and rising output would have caused expected real yields and expected inflation to rise, thereby driving nominal interest rates up, not down”
    Does QE through diminishing the inflation expectations and long-term nominal rates, creates a propitious environment for long-term capital intensive projects pushing long-term productivity up? So can I understand that QE through manipulating expectations downwards indirectly creates a good environment for long-term projects pushing the economy to flourish or am I wrong??, I just want to know how does QE may help the economy even indirectly, thanks!

  5. 5 Wu September 3, 2012 at 6:44 am

    Why do you need to be so obnoxious about this?

    You say “… show that Bernanke is totally clueless about how QE could be effective. If Bernanke thinks that QE can only work through the channels he discusses in his speech, then he might as well pack his bags and go back to Princeton now now without waiting for the current or the next President to appoint his successor. He is useless, and his tenure has been waste of time. ”

    Would you say that to Bernanke’s face? What is it about the internet that turns people into dicks?

  6. 6 David Glasner September 3, 2012 at 7:03 am

    You are right. I got carried away, and I should not have used such harsh language.

  7. 7 Diego Espinosa September 3, 2012 at 8:13 am

    Did expected real rates first rise or fall when the U.S. exited the gold standard?

  8. 9 Freude Bud September 3, 2012 at 10:38 am

    While it is true that controlling the price at Cushing wouldn’t effect global price of oil, controlling the price of Brent would. Globally, most oil is bought on long term contract at a set discount or premium to Brent. Hence if you are able to control the price of Brent, you are able to control the vast bulk of crude oil costs, globally.

    I find it hard to credit the statement, even revised to be less sensational, that Bernanke “is totally clueless about how QE could be effective.”

  9. 10 David Glasner September 3, 2012 at 7:17 pm

    Russ, Interesting idea, but it would take a lot of work to implement. It’s seems like a kind of mirror image of Silvio Gessel’s idea of stamped money.

    Benjamin, I hope that this is not the new normal.

    Julian, Forward guidance is always contingent on conditions, but the Fed is not committing itself to any target. If there were a NGDG level target, there would be no need to commit to a particular interest rate for an extended period.

    Pablo, That could be one interpretation of QE, but I don’t think that it is anyone’s preferred interpretation.

    Diego, My memory is that US rates remained very low even after FDR devalued the dollar, but I don’t have any precise numbers handy. I would be surprised if there were no increase rates at all.

    Patrick, :)

    Freude Bud, The effect that you are positing results from a peculiarity in the way contracts on written. If Brent crude were being manipulated, traders would start benchmarking in terms of another price.

  10. 11 Freude Bud September 3, 2012 at 7:29 pm

    LIBOR is manipulated. Haven’t seen much of a move away from that particular benchmark. Just saying …

  11. 12 Russ Abbott September 3, 2012 at 11:03 pm

    David, Thanks for reading and commenting on my suggestion. It would take at least an act of Congress to give the Fed the authority to impose a rebate/surcharge. And it’s unlikely Congress would do such a thing until both parties want government to succeed. But if we could get past that hurdle, I don’t think the mechanics would be that difficult. A Fed rebate/surcharge could piggyback on existing sales tax mechanisms. Once in place it would be such a clean, direct, and powerful way to nudge the economy, it would be worth the effort required to implement it.

  12. 13 David Glasner September 4, 2012 at 5:44 pm

    Freude Bud, LIBOR is manipulated, but it is not clear to me at least by how much and for how long. If the manipulation of the price of the benchmark implies disequilibrium pricing for other stuff that is benchmarked to it, the benchmark can be switched or the premium or discount with respect to the benchmark can also be altered.

    Russ, I don’t know really one way or the other about the implementation. It seems hard to me, but that’s not based on any concrete knowledge.

  13. 14 Benjamin Cole September 4, 2012 at 8:32 pm

    David-

    The “new normal”? Have you checked out Japan?

    We very much have to consider if QE needs to be sustained, not as in months, or seasons, but in terms of years.

    That leads to issues, such as how the Fed handles a growing balance sheet. It can turn out to be a positive, by deleveraging the nation if the Fed buys Treasuries.

    If orthodoxy does not provide prosperity, then we much think about unorthodox solutions.

    I realize monetizing the debt is right up there with animal abuse in terms of popular ideas with economists. But times change (hopefully never for animal abuse, which I ever hope is regarded poorly, but for the “sin” of monetizing debt).

  14. 15 Mark Stamatakos September 4, 2012 at 9:49 pm

    My comments are usually not welcome here, but I would add that beyond all this dissection of Bernacke’s insights are some pretty objective facts worth considering.

    Nobody in their right mind has any real idea how to control the economy (that is why a blog like this exists, right?). Debating the theory is fascinating, but we are still debating the most relevant causes to the Great Depression as well. Something so complex, so many variables, and no way to know which ones to solve for.

    All central banking boils down to the idea that people making these decisions (like Bernacke) are doing so objectively and neutrally. Please. If you believe that, I might have some prime real estate for you in Manhattan…nevermind.

    I suppose we could argue that technocrats are able to make decisions outside of a political vacuum. And I suppose we could call ourselves profoundly naive. Government has served its own interests by fiddling with how we calculate inflation, employment, and budgetary figures? And the Central Bank doesn’t have interests to serve?

    Central banking has created an economic system out of fiat money that rewards those at the top and drives wealth out of the middle class. I have been feeling that up close and personal as another 6 trillion has been added to the national debt in the last four years and my cost of living spirals out of control.

    Why are current Fed policies directed at keeping inflation as low as possible while ignoring negative employment figures. Why is it ok to push bailouts (ok, I hear Quantatative Easing used instead which is a lovely euphemism for bailout) on citizens increasing debt and deficit? Why does the Fed tinker so much with the economy when the poop hits the fan, but leave it completely alone when things are running great. In my view, we are just creating mega booms and busts by doing this. Better to leave it alone.

    I am not here to offend David, but why are we putting our faith in the very same institutions that allowed the financial crisis to explode in the first place? Why wouldn’t I look at how big banks and brokerage houses faired after the 2008 crash and conclude that “independent” central banking is not influenced by the private financial sector? Lehman brothers goes under but Goldman Sachs comes out smelling like a rose?

    I guess at the end of the day, I wonder how much taxes my kids will be shoveling over to deal with debt that continues to accrue recklessly and in total disregard to dealing with reality. QE 3 will add more. Why not accept that pain in dealing with our problems is inevitable and let the business cycle run its course? When will we stop deluding ourselves.

    Regulations we need above all others, somehow, is to get financial institutions to:
    1) Stop over leveraging themselves
    2) Stop rewarding reckless risk taking
    3) Let banks that do not follow 1 and 2 fail. No more lender of last resort. Central banking ENCOURAGES risky behavior from financial institutions precisely because it exists.

  15. 16 BobJones23 September 5, 2012 at 8:52 am

    You have no credibility whatsoever. You don’t even understand the concept of real rates.

    “It was only when the program petered out, after adverse supply shocks caused a temporary blip in commodity prices and CPI inflation in the spring of 2011, that real interest rates and inflation expectations began to drift downwards again.”

    Real Rate = Nominal Rate – Expected Inflation

    Thus, if inflation expectations are drifting down, real rates are rising…..

    And Again….

    The combination of rising prices and rising output would have caused expected real yields and expected inflation to rise, thereby driving nominal interest rates up, not down.

    Yes, QE2 did increase inflation expectations, causing long-term treasury yields to rise. However, going back to our basic equation…

    Real Rate = Nominal Rate – Expected Inflation

    With the Fed pinning short-term rates at the zero lower-bound, the yield curve steepened dramatically. However, the point of QE is to use unconventional means to create a short-term negative real rate that equals the natural rate of interest required to return the economy to potential, which in our current environment is negative.

    So the net effect is, the short-term nominal rate is pegged (unchanged) and expected inflation increased, hence short-term real rates declined….they didn’t increase…

    Go back to Econ 101.

  16. 17 Gkm September 5, 2012 at 3:27 pm

    What a waste of my time. Someone who doesn’t know that in a true economic expansion real prices FALL should be considered clueless in all respects. Adam Smith weeps for you sir.

  17. 18 Mark Stamatakos September 5, 2012 at 5:53 pm

    If you guys are calling me an idiot, I’m not disagreeing with you. I’d still like someone here, among what I consider to be very economically savvy people, to explain to me why anyone should believe that CPI is a valid tool for measuring real inflation.

    Can someone explain to me how Substitution and Hedonics in the current CPI formula isn’t a shell game? These seem like willful deceptions to me.

  18. 19 David Glasner September 5, 2012 at 8:12 pm

    Benjamin, My assumption has been, and still is, that what is happening now is a cyclical or aberrational deviation of the economy from its long run growth path. I thought that this is what your position was as well. You seem to be suggesting that the economy has moved permanently to a lower long-term growth path. If that were indeed the case, I think that the case for increasing inflation or increasing aggregate demand would be weakened. So I am not sure what to make of your comment.

    Mark, Your comments are totally welcome, but accusations of wrongdoing, indeed criminal wrongdoing, based on no evidence but the accuser’s own financial situation, are not welcome whether they come from you or anyone else.

    BobJones23,

    You said:

    “Real Rate = Nominal Rate – Expected Inflation

    “Thus, if inflation expectations are drifting down, real rates are rising…..”

    Your conclusion follows only if nominal rates are constant. Nominal rates have been falling.

    You said:

    “With the Fed pinning short-term rates at the zero lower-bound, the yield curve steepened dramatically. However, the point of QE is to use unconventional means to create a short-term negative real rate that equals the natural rate of interest required to return the economy to potential, which in our current environment is negative.

    “So the net effect is, the short-term nominal rate is pegged (unchanged) and expected inflation increased, hence short-term real rates declined….they didn’t increase…

    The yield curve did not steepen dramatically, long-term nominal rates having fallen pretty steadily for over a year. Expected inflation did increase immediately after QE2 was launched, but within six months they started to fall. Expected inflation is below what it was in early 2011 when QE2 petered out. You may want to check the facts.

    Gkm, When was the last true economic expansion? the Great Depression when prices fell by about 50% in less than four years?

    Mark, I don’t know whom you are talking to. I actually don’t believe that the CPI is the best tool for measuring inflation. (I don’t understand what “real” has to do with inflation.)

    Substitution and hedonics are based on the basic theory of consumer choice which tells us that people adjust to relative price changes by buying more of the stuff that gets cheaper and less of the stuff that gets more expensive. Thus, when prices change the idea is to estimate how people would alter the proportions of their purchases while still attaining the same level of satisfaction that they attained before the relative price changes. It is totally based on the basic theory of consumer choice. You may not like it, but it is standard economic theory. It has nothing to do with deception unless you are ignorant of economic theory or have a hidden agenda that you are trying to advance.

  19. 20 Mark Stamatakos September 6, 2012 at 7:44 pm

    David, and anyone else.

    Being dismissive of my assertions that inflation (as it is currently tracked) borders on intentional deception is certainly your right (it does create the impression among your readers that I am an ignorant Tea Partier with an IQ of about 5). However, by not explaining to me or anyone else why the current tracking system is adequate or legitimate, you are not doing much to help a layman like myself make sense of the TITANIC difference between what I experience and what I am being told. You ultimately explain this away as “standard economic theory.”

    You of all people should know that theories as they exist in real time are always subject to scrutiny and change. And the Fed has been tinkering with CPI now quite a bit in the last 20 years. Does that have anything to do with the ballooning federal deficit? Its certainly possible. I guess what I am saying is a healthy does of skepticism about how we are tracking what is really going on (unemployment and inflation as two examples) might be warranted considering the “State of the Nation.”

    I don’t make these claims because I am convinced the government is engaged in a criminal enterprise, but I do make them because the group that tracks this data is ultimately beholden to the “group” that runs the white house. I am simply offering that a truly independent FED seems to be questionable.

    Further, these are not views that I, your apparent “Ron Paul” crackpot, are solely concerned about. These are views that are pushing into the mainstream.

    I just checked out the World Bank website the other day to find that food prices worldwide are up 36% this year. I assume that number is worse for some people around the world. But in my own experience, food prices are definitely north of 2%. And no, I am not substituting milk, bread and eggs for ramen noodles to help “alleviate” my the price increases as CPI substitution suggests. I still need milk bread and eggs.

    And why is it so unreasonable to assume that the Fed has engaged in an endless policy of printing endless amounts of fiat currency to keep the value of our dollar down? I am concerned and looking for answers. If this is not the forum to have those things discussed, I apologize. I do not mean to impugn you or anyone else, just help get some understanding.

    http://inflationdata.com/articles/2012/06/08/federal-reserve/

    http://www.cbsnews.com/8301-505144_162-57387655/inflation-not-as-low-as-you-think/

    http://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&ved=0CCgQFjAB&url=http%3A%2F%2Fresearch.stlouisfed.org%2Fpublications%2Fregional%2F97%2F07%2FCritiquing.pdf&ei=xFxJUPf0JIuc8QSOzYHICA&usg=AFQjCNEOEyT67fQ7b6ZougXptjLOZuu6Pg

    are these links decent sources or biased?

  20. 21 BobJones23 September 7, 2012 at 2:39 pm

    Ok…let’s do some back and forth. It is you who needs to check the facts.

    You say:

    “Actually, the initial success of QE2 was associated with rising long-term rates and rising inflation expectations. It was only when the program petered out, after adverse supply shocks caused a temporary blip in commodity prices and CPI inflation in the spring of 2011, that real interest rates and inflation expectations began to drift downwards again.”

    Go to this website:

    http://www.clevelandfed.org/research/data/inflation_expectations/archive.cfm?dyear=2011&dmonth=6

    The focus is on the 2nd chart of real interest rates….

    1) Pull the July 2010 iteration. This is the month before Bernanke signaled QE2 and the expectations entered the market.

    Conclusion: The real interest rate is slightly POSITIVE due to the deflationary expectations taking over the market.

    2) Pull the December 2010 iteration. QE2 has been in effect for 2 months. And where has the real interest rate gone? It’s almost 200 bps negative!

    Conclusion: QE2 lowered real rates to negative territory, even in a context of “rising long-term [nominal] rates.”

    3) Pull the May 2011 iteration. Real rates are well below 0 at -300 bps!

    OVERALL CONCLUSION: REAL RATES BEGAN DRIFTING DOWN IMMEDIATELY AFTER BERNANKE SIGNALED QE2 AT JACKSON HOLE IN 2010. YOU GET IT COMPLETELY BACKWARDS! WHEN QE2 ENDED, THE SPRING COMMODITY BLIP PASSED, AND THE EURO CRISIS HIT REAL RATES SPIKED UPWARD DUE TO DEFLATION COMING BACK INTO THE PICTURE.

    Moreover, you completely contradict your response to my article. You say the “initial success of QE2 was associated with RISING long-term [nominal] rates.” Yet in your response to my article you say:

    “The yield curve did not steepen dramatically, long-term nominal rates having fallen pretty steadily for over a year”

    No one is denying they’ve fallen over the last year. There has been no QE or stimulus to drive them higher. I was referring to QE2. Switching time periods to try to counter an argument is just ridiculuous.

    So two key points here:

    1) You apparently don’t understand what “steepening” means related to the yield curve.

    2) You don’t get that when informed economists discuss real rates in the context of QE, nominal rates don’t mean anything. In the monetary policy sense:

    Real Interest Rate = Nominal FED FUNDS RATE – Expected inflation

    The Fed Funds is at the zero-lower bound and has been for over 4 years! All that matters is expected inflation in the context of real rates.

    QE is financial repression. It’s about making cash a negative yielding-asset in order to drive people into riskier assets (e.g. higher stock prices, lower corporate bond yields, MBS, etc.)

    By accomplishing this, people are wealthier (at least on paper) and credit is easier for companies and individuals to attain, and capital investment makes more sense on an NPV basis.

    That is all….

  21. 22 Tas von Gleichen September 8, 2012 at 8:32 am

    Great piece. Thanks for the update! Nobody is perfect not even Bernanke. Someone else is going to take over his post and we will see if that person will do a better job.

  22. 23 David Glasner September 9, 2012 at 7:49 am

    Mark, I have already told you at least three times that I don’t know enough about how the CPI is calculated to explain it to you. It is not my job to explain to you why the CPI is legitimate. My objection to your posts is the insinuation that, because the CPI estimates don’t agree with your personal experience and because you don’t understand how the CPI is calculated, the index is corrupt. I have no problem with your IQ, which I am sure is well above average, but I have a problem with your arrogance and self-absorption. I am not explaining anything away, I simply made the point that substitution is a basic idea in the construction of price indices, and most people who have worked with price indices acknowledge that it is appropriate to take substitution into account. The fact that you are not substituting is irrelevant. Someone must be substituting, otherwise taking substitution into account wouldn’t change anything.

    To my knowledge the Fed is not involved in estimating the CPI, so I have no idea what you mean by “the Fed . . . tinkering with the CPI.” And no it has nothing to do with the ballooning federal deficit, which is mainly the result of the fall in output and income since 2008.

    The group that tracks the data for the CPI is the Bureau of Labor Statistics. You are insinuating something improper when you say that the BLS is “beholden” to “the group that runs the White House.” Unless you have some evidence of wrongdoing, I resent the insinuation. And the Fed, which is independent of both the BLS and the White House, is totally out of this loop.

    If world food prices have risen by 36% this year, it’s because of drought and the ethanol mandate. The Fed has nothing to do with either of those.

    BobJones23, The real interest rate chart that you are looking at is the real interest rate over a one-year time horizon. Because the one-year nominal rate has been near the zero-lower bound, the real interest one-year interest rate has basically been moving inversely with expected inflation. I am looking at the nominal and real rates and expected inflation over a ten-year time horizon.

    Tas, Thanks.

  23. 24 Mark Stamatakos September 10, 2012 at 12:51 am

    David…

    I am sorry you feel I am arrogant. Not my intent. I appreciate your sensitivity at defending the government as well, and I not here to bash the government. I am trying to learn here, so if my views are wrong or misplaced, I need the info to see it differently. I have a slapdash understanding of this stuff because I do not have an economics background.

    I am not attacking a particular political party here either, or a particular person. When I say the BLS is “beholden,” I don’t have proof. But I ask you to consider that I am skeptical based on how we are told unemployment is only 8.3%. Why don’t they report real unemployment? The BLS reports this figure and inflation. Well, and do they include the 1.2 million Americans who aren’t looking for work? This 8.3% number is floated around to average Americans who do not understand what kind of gimmickry is being played here. I see that and feel I can make some assumptions about how much I am supposed to value inflationary numbers. We disagree, but it is stunning to me that you can’t even see that its possible for someone to be skeptical of this figure.

    I am also seeking understanding for why over 60% of our budgetary deficit is credit created out of thin air. I am trying to understand why inflation is being reported to us by the BLS as the figures that are stated. You’ll defend the independence of all these groups, maybe justifiably so, but as a regular consumer I am concerned its not kosher.

    David….could you evaluate the following statement for me…

    Fed credit expansion unassociated with the production of new goods and services — that is, the creation of demand without supply — is the hidden inflationary mechanism behind the world dollar disease. However, when the Fed tightens credit abruptly and substantially, as in 2006, the process is reversed with deflationary consequences (2007-2009).

    Does this make sense or is this statement conservative hogwash. Perhaps the source material I read is the problem.

    My opinion: The Fed has everything to do with the surge in prices of food from my viewpoint. You are blaming it on this year, but if you study the numbers you’ll note that food prices began surging in 2008, when the first bailout hit the global markets. Doesn’t our fiat currency expansion affect overseas markets? Why did fuel and food prices both surge in 2008 up til today (and continuing). The reason I continue to harp on CPI is because I see some evidence that a more friendly CPI might go lockstep with a deliberate policy to drive the dollar’s value down. I didn’t say this is what is happening, I am suggesting this is how I see it. Its one view David, which you obviously disagree with.

    Finally David…just so you understand my thinking…

    1/3 or even more of our debt is involved in making weapons and fighting wars around the world. I guess you could call the relationship between our politicians and the pentagon a little suspect. Unless you believe we need to be spending 800 billion dollars a year on defense. These kinds of relationships make the average person skeptical of the neutrality of any government agency, with or without proof.

  24. 25 David Glasner September 12, 2012 at 3:34 pm

    Mark, I am sorry, first you apologize for your lack of knowledge and understanding and then you launch into a new attack based on your ignorance. There are lots of different ways to measure unemployment; none are perfect. Do you know whether there has been any recent change in the way that the government measures unemployment? If you do, why don’t you let us know what it is? If there hasn’t been, what point are you trying to make by asking “why don’t they report real unemployment?” If there has been no change in the way unemployment is measured then there is no gimmickry involved. It may be inaccurate, but that is completely different from suggesting that there is deliberate deception going on. You say that you are stunned that I can’t even see that its possible for someone to be skeptical of this figure. I am perfectly willing to accept skepticism about the accuracy of the figures, but I am not willing to accept unfounded accusations of impropriety, which you keep making even after you say that you lack knowledge of the issues that you are making accusations about.

    The statement that you quoting is not seriously mistaken except in using the term “world dollar disease” which is pure nonsense.

    Food prices are known to be volatile, they go up sharply as they did in 2008 and they come down sharply as they did in 2009. Sometimes it’s the result of monetary factors, more often it’s the result of factors affecting the demand for or supply of specific commodities rather than for commodities in general.

    I don’t see what the size of our defense budget has to do with anything we have been talking about, so I am not going to respond to you last question. But I will say that the pattern I detect in our exchanges is beginning to become tiresome to me. I don’t want to cut anyone off on this blog, but if you have any more conspiracy theories up your sleeve, I would really appreciate it if you try them out on someone else’s blog.

  25. 26 Robert Reilly September 13, 2012 at 5:40 pm

    I feel confused about QE and monetary policy.

    a) What Do Central Banks Control?
    Nick Rowe says,
    “… what central banks really really ultimately do is determine the value of that $ unit.”
    I read him as saying that a central bank can have various ways of describing the only thing it does: Control the supply of the money unit.
    And therefore, things don’t change when interest rates hit zero, because you can still print money, and that’s as effective, or not, through essentially the same channels, as it always is.
    (“Imagine an alternate monetary history where central banks had maintained direct convertibility of their monetary liabilities into gold. But not at a fixed price of gold, like under the old Gold Standard. Instead, they adjusted the price of gold at their discretion.
    We could imagine some economists in that alternate monetary history saying it would be better to adjust the price of gold to target the NGDP level path, rather than to target inflation.
    But we could not imagine an alternate Michael Woodford advocating an NGDP level path target in order to escape the Zero Lower Bound on nominal interest rates.”)

    b) So What Does That Imply About How QE2 Can Be Working?
    In evaluating Bill Gross’ prediction of a spike in interest rates at the termination of QE2, Krugman writes,
    “I don’t buy the notion that rates are low only because the Fed is doing QE2.”
    I take it that if stopping QE2 is not going lead to a rise in interest rates then starting it did not make them fall.
    And David Glasner pounds the table in his version of “it’s stocks, not flows”:
    “The long-term assets whose supply the Fed is controlling are but a tiny sliver of the overall stock of assets whose prices adjust to maintain overall capital market equilibrium Affecting the market for a particular group of assets in which it is trading actively cannot force all the other asset markets to adjust accordingly unless the Fed is able to affect either expectations of future real rates or future inflation rates.”
    That is, the Fed cannot directly drive long rates down by bidding up long debt; only by affecting expectations of inflation or growth, and thus return on long debt with respect to an effectively fixed supply. As Krugman puts it:
    “The flow – the rate of purchases – matters only to the extent that it affects expected returns.”

    So I would take Krugman (and Glasner) to agree with Rowe: The Fed can print money, getting it out there in various ways; recently the usual way has been to promise limitless short-term borrowing or lending to control the fed funds rate. But it can’t directly control long rates, not even by directly buying or selling long-dated rate instruments. The only effect Fed action has on long rates are through expectations of future inflation (the main driver of long rates) or future real rates (presumably responding to NGDP growth?)

    c) So How Can QE2 Be Anything Other Than “Printing Money”? (Not That There’s Anything Wrong With That.)
    So here’s my confusion: Regarding QE2, Krugman said,
    “What is the Fed actually doing? It isn’t “printing money”; it has been buying long term bonds, paying for them by adding to (interest-paying) bank reserves. In effect, it has been borrowing short and lending long.”
    “When you look at it [as consolidated with the Treasury balance sheet], we’re talking about a reduction in the average maturity of the debt held by the public, which should, other things equal, raise the price of long-term debt and hence reduce long-term interest rates.”

    But, but … a) it seems right that the Fed can’t single handedly drive long rates, and b) Glasner seems right when he argues that, to the extent QE is working we should see long rates rising not falling, as inflation and real rate expectations rise. And it seems that nominal rates rose during both QE1 and QE2 (as did the stock market.)
    And c) if the Fed is funding its purchases by placing reserves, isn’t it “printing money” with both the new reserves and the interest it pays on them? And this increase in the money supply, by affecting the value of the $ unit, affects (hopefully) inflation expectations, demand expectations, investment expectations, growth expectations?

    Oh, and, regarding an earlier comment: Having been on the receiving end of LIBOR manipulation: It has been obvious for years, it’s usually small and transient, and it was only truly egregious and persistent for a short period (a week or so) in 2008 when stress-testing was going on. Settles have always been manipulated in everything. We’re used to it; but it’s getting better, and it is nicer with the transition to VWAP settling for liquid contracts.


  1. 1 Economist's View: Links for 09-04-2012 Trackback on September 4, 2012 at 12:12 am
  2. 2 David Glasner Has Some Very Smart Things to Say About Ben Bernanke at Jackson Hole | FavStocks Trackback on September 4, 2012 at 12:44 am
  3. 3 How the Fed has seriously misunderstood the effects of QE | Screw Cable Trackback on September 4, 2012 at 6:21 am
  4. 4 Counterparties: Mario Draghi’s shopping list | Felix Salmon Trackback on September 4, 2012 at 2:50 pm
  5. 5 10 Mid-Week AM Reads | The Big Picture Trackback on September 5, 2012 at 6:46 am
  6. 6 Signs of QE’s Success Actually Show Its Failure Trackback on September 5, 2012 at 10:30 am
  7. 7 John Cochrane Misunderestimates the Fed « Uneasy Money Trackback on September 6, 2012 at 9:52 pm
  8. 8 Counterparties: Mario Draghi’s shopping list | Latest News Trackback on September 8, 2012 at 7:42 am
  9. 9 AD Volume, Buy Power Comparison | Prudent Trader Trackback on May 28, 2013 at 7:32 am

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About Me

David Glasner
Washington, DC

I am an economist at the Federal Trade Commission. Nothing that you read on this blog necessarily reflects the views of the FTC or the individual commissioners. Although I work at the FTC as an antitrust economist, most of my research and writing has been on monetary economics and policy and the history of monetary theory. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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