Printing Money and the Fed's exit strategy

[childofprodigy]

So Ben Bernanke has been cranking up the printing press lately as you can see from the monetary base chart: To view links or images in this forum your post count must be 2 or greater. You currently have 0 posts.

Currently the vast majority of these printed money were used to buy up toxic assets from the banks and the banks are currently keeping them in the fed's reserve, so they haven't flowed into the economy....

Now, if they do manage to flow into the economy, this will undoubtedly create uberinflation and the collapse of the dollar...And apparently, Bernanke has an exit strategy for this scenario: To view links or images in this forum your post count must be 2 or greater. You currently have 0 posts.

What do you guys think about this "strategy"...do you think it's gonna work, because if not, we're all screwed

[Causa Mortis]

Its not as simple as "minting more money causes more inflation". Its a lot more complicated than that - velocity is just as important as total money supply in determining total expenditure in an economy.

MV=PY.

That's mathmatically true by our definition of each term. Thus the collapse in velocity resulting from banks and households holding very large real cash balances was reasonably responded to with a large monetary expansion.

Velocity fell by a factor of 2. The Fed had to double the money supply to prevent The Great Depression 2.0. Am I concerned about the exit strategy? Of course, but cross that bridge once unemployment drops below, say, 7.5%.


Bernake has made many, many mistakes so far, but doubling the money supply in the face of the collapse in velocity is not one of them.

[Night Runner]

If the uber-inflation doesn't come, all will be well. If it comes, my fixed-rate student loans won't be such a burden anymore. :cool: Sure, the quality of life would drop rapidly, but we'd all be in the same boat...

[JohnDoe]

Also pointing out although the dollar is weak we still have quite a ways to move before we get near all time lows from earlier in the cycle. (1.6's, currently at 1.49). Of course if the dollar keeps dropping vs the euro 0.6% a day... we could get there really quickly.

[zibber]

Causa Mortis, how does doubling the "money supply" not lead directly to inflation?

Am I being simplistic when I say deviation from the gold standard -> inflation? Bringing so much more money into circulation seems like literally stealing from people who have money.

If the uber-inflation doesn't come, all will be well. If it comes, my fixed-rate student loans won't be such a burden anymore. :cool: Sure, the quality of life would drop rapidly, but we'd all be in the same boat...

Well.. all but the rich, of course.

[JohnDoe]

Causa Mortis, how does doubling the "money supply" not lead directly to inflation?

Am I being simplistic when I say deviation from the gold standard -> inflation? Bringing so much more money into circulation seems like literally stealing from people who have money.



Well.. all but the rich, of course.

My macro econ is a bit rough, but I believe as long as the supply of goods expands with the demand provided by increased money theres no reason to expect inflation. The hope is that increased lending will produce actual expansion of the production capacity of the economy and this will prevent inflation.

Also doubling the money supply does not necessarily lead to inflation. If I double the money supply and then stick it in bank vaults where no one can spend it there is no increased spending so no inflation.

[deinotes]

My macro econ is a bit rough, but I believe as long as the supply of goods expands with the demand provided by increased money theres no reason to expect inflation. The hope is that increased lending will produce actual expansion of the production capacity of the economy and this will prevent inflation.

Also doubling the money supply does not necessarily lead to inflation. If I double the money supply and then stick it in bank vaults where no one can spend it there is no increased spending so no inflation.
Let see some causes where the money went to :

-Banking bailout
-Cash for clunkers.
-Tax rebate
-GM bailout
-Irag/afghanistan war


Yeah probably no inflation it are all means to produce real goods or went to companies that make top of the line products.

[JohnDoe]

Let see some causes where the money went to :

-Banking bailout
-Cash for clunkers.
-Tax rebate
-GM bailout
-Irag/afghanistan war


Yeah probably no inflation it are all means to produce real goods or went to companies that make top of the line products.


Actually the vast majority of the money that we need to be worrying about is the money being used to buy the securitized morgages. The banking bailout is not an inflationary worry as long as they are conserving capital.

[deinotes]

Actually the vast majority of the money that we need to be worrying about is the money being used to buy the securitized morgages. The banking bailout is not an inflationary worry as long as they are conserving capital.
I found this List :
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I think from all the things on the list there is only one thing that would be long term helpful for the economy and that is this:

Advanced Technology Vehicles Manufacturing program

The rest is almost all a inflationary worry. And i find it sickening that they call it a investment since a lot will only end up just as temporary relief. And will only serve as a huge burden on future generations.

[Causa Mortis]

Causa Mortis, how does doubling the "money supply" not lead directly to inflation?

Money Supply * Velocity = Price * Output

That equation is true by definition of the terms.

The money supply was doubled by the federal reserve last November. There has been zero meaningful inflation since that time. This is because velocity fell by a factor of two. Thus the demand side of this equation, Money*Velocity, has actually moderately declined, and that's why we've also seen a modest fall in the price level and output. Going forward, velocity is likely to stabilize and the Fed will have to reduce the money supply in order to prevent an inflation.

Am I being simplistic when I say deviation from the gold standard -> inflation? Bringing so much more money into circulation seems like literally stealing from people who have money.

Deviation from the gold standard does not necessarily generate an inflation, and a gold standard alone will not eliminate deviations in the price level. The only surefire way to stabilize the price level is to grow the money supply at the economy's long run potential rate (see the monetary work by Milton Friedman), or have government exit issuing currency altogether (which is not feasible).

Yes, inflation is a tax or theft of value from those who hold money in non-interest bearing forms, but current monetary policy is in no way inflationary.

Also pointing out although the dollar is weak we still have quite a ways to move before we get near all time lows from earlier in the cycle. (1.6's, currently at 1.49). Of course if the dollar keeps dropping vs the euro 0.6% a day... we could get there really quickly.

Actually this is healthy and driven by market forces. It will stimulate net exports.]

If the uber-inflation doesn't come, all will be well. If it comes, my fixed-rate student loans won't be such a burden anymore. Sure, the quality of life would drop rapidly, but we'd all be in the same boat...

If you're in a position of a substantial amount of net debt, I would welcome almost anything short of a hyperinflation. Your wage is a reflection of your marginal value to the firm, and provided you're doing better than minimum wage, your wage is very likely to rise directly with a rise in inflation.

[JohnDoe]

If you're in a position of a substantial amount of net debt, I would welcome almost anything short of a hyperinflation. Your wage is a reflection of your marginal value to the firm, and provided you're doing better than minimum wage, your wage is very likely to rise directly with a rise in inflation.
If you don't have assets :(

[Causa Mortis]

If you don't have assets :(

I used "net debt".

And if you're that worried about inflation, buy TIPS, commodity indexes, or REITS.

[LaoTzu]

What do you guys think about this "strategy"...do you think it's gonna work, because if not, we're all screwed

The CDN dollar is almost at par (again)... not good for us up here... Its got nothing to do with our economy, it's the US dollar dropping. Stop it pls! :)

[nocturne]

The recent monetary expansion by the Federal Reserve does not threaten hyperinflation, because it has been offset by a corresponding increase in money demand, i.e. a decline in the velocity of money.

However, two things concern me. Although the Federal Reserve has stabilised the price level, I am concerned that they have also stabilised relative prices. When an economy is recovering from a bust, especially one associated with a bubble, relative price adjustments should not be obstructed. During a boom a lot of resources are misallocated, and the economy must be allowed to restructure. To what extent has the Federal Reserve propped up sectors of the economy that should shrink? I don't know, but trouble could be ahead.
The Federal Reserve bought a lot of "toxic assets". When money velocity starts to pick up, it probably will not be able to sell these assets for nearly as much as it paid for them, and the difference, unless offset by other means, will be inflationary. I don't know enough about the inner workings of the Federal Reserve to know how sensible this concern is. However, I am less concerned about it than I would have been since the Federal Reserve obtained the power to pay interest on bank reserves.In the short term, I wouldn't expect severe inflation because of the Federal Reserve's recent actions. In the long term, I consider the Federal Government's spending habits as a far greater inflation threat.

[eagleseven]

Compounded with this problem is the fact that in the near-term, our budgets are unsustainable. With the baby-boomers retiring and thus breaking Social Security/Medicare, combined with our current deficits and national debt, the Government will be forced to print money to simply stay liquid.

The amounts we're talking about (in the trillions) are sure to destroy the dollar, which is what has our major creditors sweating bullets. This is why countries like China are buying all the gold and non-US currencies they can.

Thomas Friedman of the NYT refers to this inevitable disaster as "the debt bomb." I cannot think of a better phrase. World governments see what is coming down the pike...

Bloomberg: Dollar Reaches Breaking Point as Banks Shift Reserves (To view links or images in this forum your post count must be 2 or greater. You currently have 0 posts.)





eagleseven added to this post, 1 minutes and 43 seconds later...

Also doubling the money supply does not necessarily lead to inflation. If I double the money supply and then stick it in bank vaults where no one can spend it there is no increased spending so no inflation.

If the banks have more (printed) money in reserve, they will inevitably feel emboldened to offer more credit, increasing liquidity. You'll see the inflationary effects of your policy sooner or later...

[zibber]

(see the monetary work by Milton Friedman)

Yeah, I kind of zone out whenever someone mentions that name.

Something about Chile and Argentina.

[eagleseven]

Yeah, I kind of zone out whenever someone mentions that name.

Something about Chile and Argentina.

Do you have a similar reaction to Marx? Or do you isolate his theory from its historically bloody applications?

Just curious?

[Causa Mortis]

Yeah, I kind of zone out whenever someone mentions that name.

Something about Chile and Argentina.

Hence why I specifically referenced his work on monetary policy. This work was first rate, positive economics.

His views on government spending and his association with right-wing regimes has very little to do with his views on monetary policy.

Do you have a similar reaction to Marx? Or do you isolate his theory from its historically bloody applications?

Just curious?

The thing is that I don't think that any of Marx's contribution to economics as an objective discipline - ie in explaining how things work - were significant, and the horrors perpetrated by the Soviets have only been matched by the Nazis.

Marx advanced a theory about population growth in the working class perpetually driving wages to subsistence levels that worked 200 years ago but that don't make sense in a post birth-control world. However his main critique - that ever-increasing levels of compeition drives real prices to unsustainably low levels and that will ultimately lead to collapse - would only apply in an economy with zero technological innovation, and even then wouldn't make that much sense.

Friedman has contributed significantly to positive economics with his insights that inflation/unemployment is only a temporary tradeoff and the life time income theory of consumption. He's associated with a few ugly regimes but nothing that bears any resemblance to the Soviet Unsion.





Causa Mortis added to this post, 3 minutes and 7 seconds later...

Compounded with this problem is the fact that in the near-term, our budgets are unsustainable. With the baby-boomers retiring and thus breaking Social Security/Medicare, combined with our current deficits and national debt, the Government will be forced to print money to simply stay liquid.

Social security is fine. Its funded through 2042.

Medicare needs massive reform, as does the health industry as a whole. It either needs nationalization or liberalization to bring spending/person back into line with international levels, and that's not going to happen - we continue to move down the path of ever-greater levels of subsidy, and eventually have to go a different route.


If the banks have more (printed) money in reserve, they will inevitably feel emboldened to offer more credit, increasing liquidity. You'll see the inflationary effects of your policy sooner or later...

But just the opposite is happening - nominal bank reserves are at all-time highs thanks to Bernake's very stupid decision to allow banks to earn interest on reserve assets.

he amounts we're talking about (in the trillions) are sure to destroy the dollar, which is what has our major creditors sweating bullets. This is why countries like China are buying all the gold and non-US currencies they can.

I'd welcome a devaluation of the dollar relative to any major currency as a result of foreign central banks no longer wishing to hold massive reserves of dollars. These don't benefit us in any meaningful way. This will stimulate net exports, savings, and employment in blue collar jobs.




Causa Mortis added to this post, 10 minutes and 42 seconds later...

To what extent has the Federal Reserve propped up sectors of the economy that should shrink?

The Federal Reserve has propped up a number of terrible companies in the financial sector, and Congress has propped up probably the least efficient manufacturing industry in the world.

Misallocating this much capital will slow long run economic growth in my opinion.

The Federal Reserve bought a lot of "toxic assets". When money velocity starts to pick up, it probably will not be able to sell these assets for nearly as much as it paid for them, and the difference, unless offset by other means, will be inflationary.

Oh just pulling the difference out of the economy will not be difficult. The Fed will just engage in open market operations or discount rate operations to offset this effect.

Guessing how velocity will shift going forward from here is the really tricky part - implementing some form of policy to impact the money supply isn't that difficult.

In the short term, I wouldn't expect severe inflation because of the Federal Reserve's recent actions. In the long term, I consider the Federal Government's spending habits as a far greater inflation threat.

Agreed - but in the mid-term, I have very real concerns about the Fed's capacity to effectively guess at shifts in velocity on its way back up. As its likely to prefer an inflation to more recessions at this point, I'm guessing they're planning on erring on the side of inflation.

[RedIrish]

Agreed - but in the mid-term, I have very real concerns about the Fed's capacity to effectively guess at shifts in velocity on its way back up. As its likely to prefer an inflation to more recessions at this point, I'm guessing they're planning on erring on the side of inflation.

I have to agree with this point. At the moment the most logical and efficient way for the US Government to deal with it's debt will be to devalue the dollar and inflate it's way out of the problem. Unfortunately, I think the Chinese as the largest creditor also see this as the most probable solution, and if they begin to take steps to counteract it's impact on their holdings, we could be in for a decade of living "interestingly".



I think the only question will be "how ugly will it get".

[nocturne]

Causa Mortis,

I suggest that the history of Friedman's complicity with Pinochet is largely mythical. Brian Doherty, over at Reason Magazine (To view links or images in this forum your post count must be 2 or greater. You currently have 0 posts.), in his article "The Economist and the Dictator (To view links or images in this forum your post count must be 2 or greater. You currently have 0 posts.)," summarises my understanding nicely (my italics).

While there, Friedman did have one meeting with Pinochet, for less than an hour. Pinochet asked Friedman to write him a letter about his judgments on what Chilean economic policy should be, which Friedman did. He advocated quick and severe cuts in government spending and inflation, as well as instituting more open international trade policies—and to "provide for the relief of any cases of real hardship and severe distress among the poorest classes." He did not choose this as an opportunity to upbraid Pinochet for any of his repressive policies, and many of Friedman’s admirers, including me, would have felt better if he had.

But that was the extent of his involvement with the Chilean regime—and it fit with a recurring pattern in Friedman’s career of advising with an even hand all who would listen to him. It was not a sign of approval of military authoritarianism. Friedman, in defending himself against accusations of complicity with or approval of Pinochet, noted in a 1975 letter to the University of Chicago school newspaper that he "has never heard complaints" about giving aid and comfort to the communist governments to which he had spoken, and that "I approve of none of these authoritarian regimes ... insofar as my personal analysis of their economic situation enables them to improve their economic performance, [it] is likely to promote not retard a movement toward greater liberalism and freedom."

Milton Friedman's opponents do him a great injustice (and betray their own ignorance) when asserting a sinister association with Pinochet's regime.

The Federal Reserve has propped up a number of terrible companies in the financial sector, and Congress has propped up probably the least efficient manufacturing industry in the world.The problem is that relative prices have a propensity toward equilibrium. Injecting money into these sectors only provides a temporary respite. If they are truly unsustainable in their current form, then nothing less than continual subsidies, whether from the Federal Reserve or Federal Government, will keep them in business. Although reform is being proposed, I doubt it will succeed, especially with politicians involved. But in the short run, letting these industries fail is likely to reignite panic and increase unemployement.

It may be a bitter pill to swallow, but sooner or later reality needs to be accounted for. Will those in power merely try and kick the can down the road? Are they looking to blow up another bubble? It seems this is precisely what happened, whether by design or accident, following the dot-com bust and September the 11th attacks.

Agreed - but in the mid-term, I have very real concerns about the Fed's capacity to effectively guess at shifts in velocity on its way back up. As its likely to prefer an inflation to more recessions at this point, I'm guessing they're planning on erring on the side of inflation.The economist Scott Sumner, who blogs over at TheMoneyIllusion (To view links or images in this forum your post count must be 2 or greater. You currently have 0 posts.) makes a very persuasive case that the Federal Reserve's monetary policy is currently too tight. The market is predicting a very slow rise in the price level, well below the Federal Reserve's implicit target, over the next couple of years. And these expectations cannot be discounted as merely inaccurate, since expectations of future spending alter spending decisions in the present. In other words, if companies and investors anticipate tough times ahead, then they may reduce expenditures today; in a world of perfectly adjusting prices or money supply this would not matter, but when we are dependent on the discretion of Bernanke, his Board of Governors, and politicians, who knows what could happen.

Sumner advocates letting market expectations of nominal GDP growth guide monetary policy. In short, set some target for nominal GDP growth, somewhere about 3-5%, and then adjust monetary policy according to market expectations. If the market expects 2% nominal GDP growth, and the target is 4%, then expand the money supply, and contract similarly when market expectations exceed the target. One consequence is that we could get a falling price level when gains in productivity are especially high. The problems associated with a falling price level are caused by an increase in the supply of money relative to demand (my preferred definition of "deflation"), but a fall in the price level instigated by productivity gains does not disrupt spending rates and so recession shouldn't be a concern.

I would prefer free banking to a central bank regime (and I know you consider that crazy), but since my preference isn't going to materialise anytime soon, I think Sumner's kind of monetary rule is among the best I have encountered.

[Causa Mortis]

Causa Mortis,

I suggest that Friedman's history with Pinochet is largely mythical. Brian Doherty, over at Reason Magazine (To view links or images in this forum your post count must be 2 or greater. You currently have 0 posts.), in his article "The Economist and the Dictator (To view links or images in this forum your post count must be 2 or greater. You currently have 0 posts.)," summarises my understanding nicely (my italics).

While there, Friedman did have one meeting with Pinochet, for less than an hour. Pinochet asked Friedman to write him a letter about his judgments on what Chilean economic policy should be, which Friedman did. He advocated quick and severe cuts in government spending and inflation, as well as instituting more open international trade policies—and to "provide for the relief of any cases of real hardship and severe distress among the poorest classes." He did not choose this as an opportunity to upbraid Pinochet for any of his repressive policies, and many of Friedman’s admirers, including me, would have felt better if he had.

But that was the extent of his involvement with the Chilean regime—and it fit with a recurring pattern in Friedman’s career of advising with an even hand all who would listen to him. It was not a sign of approval of military authoritarianism. Friedman, in defending himself against accusations of complicity with or approval of Pinochet, noted in a 1975 letter to the University of Chicago school newspaper that he "has never heard complaints" about giving aid and comfort to the communist governments to which he had spoken, and that "I approve of none of these authoritarian regimes ... insofar as my personal analysis of their economic situation enables them to improve their economic performance, [it] is likely to promote not retard a movement toward greater liberalism and freedom."

Milton Friedman's opponents do him a great injustice (and betray their own ignorance) when asserting a sinister association with Pinochet's regime.

I don't consider myself a Friedman opponent. His positive economic work is first rate - the only other economist you can mention in the same breath from this century is Keynes. That said, his association with the Reagan, Thatcher, and Pinochet regimes has rightly marred his reputation, regardless of how much he supported each. Great economist, terrible entries into the political realm to aid or directly support regimes that were generally authoritarian, militant and crony-capitalist.

But in the short run, letting these industries fail is likely to reignite panic and increase unemployement.

You can offset the drop in the money supply, velocity, and aggregate demand associated with a bank failure or large manufacturer with compensating increases in the money supply. Because of the difficulty in calculating the impacts of large shifts in velocity, this policy is likely to be more inflationary than the sterile bailouts as practiced by Bernake up to November of last year. I prefer a policy that is likely to generate a moderate inflation over one that does not allow creative destruction to occur and that generates excess moral hazard.

In other words, if companies and investors anticipate tough times ahead, then they'll reduce expenditures today; in a world of perfectly adjusting prices or money supply this would not matter, but when we are dependent on the discretion of Bernanke, his Board of Governors, and politicians, who knows what could happen.

That's the entire problem - what happens with inflation is entirely dependent on velocity. Velocity has been somewhat unstable since the early 1980s and extremyl unstable over the past year. Projecting what is going to happen with velocity is at this point impossible, thus I think that the Fed is likely to err on the side of inflation as velocity picks back up.

The decision to pay interest on reserves will serve to make this problem even more complex. It adds a new variable that we haven't seen before into the equation (unpredictability surrounding velocity being the most difficult problem a central banker faces, therefore those things that increase instability of velocity are generally undesireable), and its one that is ceterus paribus deflationary.

Current Fed policy probably is too tight for maximizing short run employment and output, I agree.

[Visum]

One thing I cannot for the life of me understand, is why there is hardly a what what, when people hear that the FED is printing money to monetize debt.
I think the question is what really is the strategy?
Personally, I believe it is to inflate the dollar long term, get out from the burden of reserve owner and steal from our lenders. We'll replace the FED and dollar as reserve with a basket currency made up of our allies, SDR, and manage the world economy via the IMF, World Bank, and UN.
Thanks China, all your hard work did wonders for my manicure.

[Krazy P]

I have to agree with this point. At the moment the most logical and efficient way for the US Government to deal with it's debt will be to devalue the dollar and inflate it's way out of the problem. Unfortunately, I think the Chinese as the largest creditor also see this as the most probable solution, and if they begin to take steps to counteract it's impact on their holdings, we could be in for a decade of living "interestingly".



I think the only question will be "how ugly will it get".

In August of 08 I titled my post exactly those words.

If you want a good analysis based on historical record, I would refer you to Rogoff and Reinhart (This Time is Different: 800 Years of Financial Folly).

The evidence suggests that it could really ugly. The bad economy is going to last a long time - and a good chance of a major war adds to the excitement!

As an aside, my problem with Mr. B started in August of 07 when he did the funky, off schedule rate cut (early in his term), which set tongues wagging and wondering how steady and calm a fellow was running the Fed? Was he prone to panic? Was he doing something for the sake of doing something - as opposed to waiting and biding his time?). He took the weird step right after a puff piece appeared in the New York Times weekend magazine. Lots of flattering "sage" portraits of the wise monetary chief. That was when I got worried. He spooked the markets and it has continued.