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Home Publications Blogs Beat the Press The Point of QE3 Could Be Higher Inflation

The Point of QE3 Could Be Higher Inflation

Thursday, 20 September 2012 04:11

The Washington Post ran a piece that highlighted the concerns of Richard Fisher, the President of the Dallas Federal Reserve Bank, that the Federal Reserve Board's latest round of quantitative easing may lead to higher inflation. Fisher notes that financial markets indicate that investors are now anticipating higher rates of inflation than was the case before the Fed's latest move.

It would have been worth noting that this is arguably the intention of the policy. This certainly is the goal of Paul Krugman and others who had advocated more aggressive action from the Fed. (Federal Reserve Board Chairman Ben Bernanke had advocated that Japan's central bank deliberately target a higher inflation rate when he was still a professor at Princeton.)

Clearly Fisher views a higher rate of inflation as being a bad thing, but it would have been worth noting that more rapid inflation is considered to be desirable by many advocates of QE3.


Comments (19)Add Comment
written by bmz, September 20, 2012 7:46
I hate to play the victim here.... but... when I retired I was advised by virtually all the professional advisors to convert most of my stocks to bonds (as in "fixed rate").
written by skeptonomist, September 20, 2012 8:50
Yields of shorter TIPS (5- and 7-year) did drop for a couple of days, but appear to have rebounded. But conventional mid- and long-term rates recently have been moving upward, which is just the opposite of what is supposed to happen in QE according to monetary-policy theorists. For increased expectation of inflation to be effective, nominal interest rates and expectation thereof have to remain low, and this is not what is happening. So far (and it is early yet) bond markets appear to be repeating what happened after the announcement of QE2 in November 2010, which is a considerable rise in both nominal conventional rates and TIPS spreads. Both movements came to an end in early 2011. There is no reason to be proclaiming QE3 a success any more than QE2 was. (Of course there is also no reason to sounding an alarm about harmful effects of supposedly increasing inflation.)
written by Ellis, September 20, 2012 9:15
I have a big question about QE3: Why is the Fed buying up mortgage backed securities? Is there no market for them, since everyone got burned in the last financial meltdown? If there was a market for them, I doubt the Fed would be buying them up. What would be the point?
written by Fed Up, September 20, 2012 11:13
What if price inflation rises, but wages don't? Won't that make the economic situation worse?
Why Inflation -- Either Expected or Actual?
written by ellen1910, September 20, 2012 11:39
Can someone explain why a plan to buy MBSs which is a plan to increase excess bank reserves should lead people to expect inflation?

Alternatively, why would lowering long-term mortgage interest rates lead people to expect inflation?

Or why would the Fed's "determination" to keep the fed funds rate near zero until 2015 (which a different FOMC committee can change in the future) lead people to expect inflation?
why..increasing..bank reserves should lead people to expect inflation
written by AlanInAZ, September 20, 2012 12:10
I think in the past the Fed was more focused on inflation than unemployment and would act quickly to raise rates at any sign of inflation. Now the thought is that the Fed will wait, even if we are in a more robust economy, to start putting on the brakes if unemployment is still "unacceptable". The extra bank reserves may spur more investment if the inflation expectation kicks in. At present the probability of Obama winning is about 70% (per Nate Silver)so investors should not expect the policy to change very quickly.

To use a sports term, it does seems a bit like a "Hail Mary pass".
written by jerry, September 20, 2012 12:57
Why would we expect printing money that sits on the shelves of banks and corporations to have an effect on inflation? Unless this money gets spent into the actual economy, and there is no indication that QE1/2 had this result, we will just have an increased money supply with a lower velocity of money - keeping prices roughly the same.
an increased money supply with a lower velocity of money
written by AlanInAZ, September 20, 2012 1:12
I think we will have an increased money supply only if the extra reserves are actually loaned out. A fear by some is that the loans will go for unproductive things like foreign investments or financial asset speculation.
written by jerry, September 20, 2012 1:29
Alan - the money supply is increased whenever the Fed purchases assets from banks, regardless of whether the banks loan out the money or spend it into the economy.

The banks and major corporations are sitting on record levels of cash. What reason would we have for thinking that this money would be spent this time around? Until the money is actually spent or loaned, we are not causing inflation.
put up or shut...
written by Peter K., September 20, 2012 1:40
I have a question for the critics in the comment section. What would constitute success for the Fed in their eyes?
written by AlanInAZ, September 20, 2012 1:51

I will study this some more but generally M2 is considered the "money supply" and this does not include bank reserves. The reserves are part of M0 which is the monetary base. Quoting Wikepedia "Economists use M2 when looking to quantify the amount of money in circulation.."

written by jerry, September 20, 2012 2:53
Alan, I'm sure you're correct, but I don't think that changes what I was saying above. If the reserves are not spent, and therefore not added to M2 as you say, then there would be no inflation. Doesn't really matter which way we categorize it, money not spent into the economy isn't doing us a whole lot of good.
written by AlanInAZ, September 20, 2012 3:22
I agree that if reserves aren't loaned out there is no benefit (also not much harm). Demand for loans, I agree, is probably mostly driven by factors other than expectation of modest future inflation. As I said earlier, a "Hail Mary pass". Supporters of the policy admit the impact will be modest.
A Successful Fed for Peter K.
written by ellen1910, September 20, 2012 4:30
The Fed buys up all federal debt with a term greater than three months and then, has a bonfire.

And for those accountancy-types worried about the Fed's "balance sheet," the Fed can ask the Treasury to issue a coin in the amount of the purchased debt, and Treasury can trade the coin for the debt -- and then, Treasury can hold the bonfire.
written by mel in oregon, September 20, 2012 5:26
it won't help the average person at all. it might raise inflation slightly which helps poorer people slightly as the dollar becomes slightly less valuable. on the other hand it makes social security checks cheaper. the biggest effect though is it's just another ruse to transfer more money upwardly from the 99% to the 1%. think $40 billion transfer per month.
Money is an antiquated notion for where we are ...
written by David, September 20, 2012 11:12
Perry Mehrling explains, here ("world without money reconsidered"): http://ineteconomics.org/blog/...considered

Looking at that way, the Fed is bleeding $40 billion out of the marketplace: some of which is risk of default, some is interest rate risk. In a way they are attempting to kill several birds with one stone: inflation will increase the value of homes, perhaps pushing some mortgages out from underwater; and risk is slowly removed from the market, so investors feel it has become safer to put some of their savings out into the market once again.
why savings will begin to go out into investments and not sit on the shelves
written by David, September 20, 2012 11:20
... buying MBSs takes risk out of the banks' portfolios so they don't have to hold on to so much cash to cover their bad investments. A $40 billion dollar MBS may be worth nothing (or maybe 80-90% of what the nominal value is, thanks to home values being less than what the mortgage was made for), but $40 billion from the Fed can be used to try to make a profit and more money.
written by Calgacus, September 22, 2012 4:09
Yup, David, that's the only way QE3 can have any real effect. By banks unloading garbage onto the Fed, making our insolvent TBTF banks solvent, and likelier to lend. Otherwise, QE3 is if anything disinflationary, anti-stimulatory. The more garbagey, the more fraudulent the banks have been, the more corruptly the Fed acts, the more QE3 can actually work. Because then it would actually be fiscal, not monetary policy - direct cash payments, welfare for the greatest fraudsters, to show them how much Uncle Sam wuvs them.
Ain't crony capitalism great?!

Of course a smarter and quicker way would be for the government to commit far smaller sums to employ ordinary people directly. And raise SS benefits & lower taxes. But, no that might not help the plan to recreate a feudal society and eventually bring back chattel slavery.
Not tbtf
written by David, September 22, 2012 4:32
Calgacus: it's not the TBTF banks that are being targeted, it's the regional and local banks, as I understand it. Those banks are the ones that get the money directly to people and businesses. Smaller funds can't fill bigger holes, get real. $5 toward a $100 interest payment gets us nowhere.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.