QE 2 - Will it do more good than bad

[imagep]

Correct, the proper terminology would have been no change in inflation or increased inflation.



I agree with the first half of your post. Debt is written in nominal terms. If there is inflation the real cost of the debt will go down. However, I disagree with your conclusion. Less inflation bad news for those who are in debt, as it makes it harder for them to repay their loan. Why do you think there have been so many delinquent home loans? The price of houses has gone down considerably since its peak during the bubble and the real burden of their home morgages went up. Inflation helps debtors and hurts creditors.

Good for me if we ever have significant inflation again - I am in debt up to my eyeballs!

 

[drz-400]

The proper terminology is disinflation.

I know, I forgot 2 key words in my original sentence:

"allowing further disinflation is a much worse senario than no change in inflation or increased inflation. Increasing inflation will also help those people who are "drowing in debt."

Disinflation, I believe you have already mentioned is a decrease in the rate of inflation. A decrease in the rate of inflation is painful because it is contractionary (unless it arises from a positive supply shock). It results in keeping the unemployment rate above the natural rate, decreased output, and also is harder on debtors.

Debtors must pay a nominal interest rate, and if the rate of inflation decreases, the real interest rate will increase. Deflation would be even harder on them, which is most definetly a situation we should avoid.

 

[drz-400]

The changes in the consumer price index is how inflation is measured. Oil and food are included in the measurement.

The Fed has no control over the prices items sell for. What the Fed can do is regulate monitiary policy which can stem inflation or stimulate it. However this is also compared to other currencies and their countries fiscal outlook on FOREX. The exchange rates and global demand are what drives inflation.

I know, I was referring to how the feds monetary policy should increase the money supply, decrease interest rates, and increase aggregate demand, which in turn should raise the level of aggregate prices. This will in turn lower the exchange rate slightly. You were the one talking about needed items and a decrease in purchasing power due to an increases in the price of needed items. That is cost push inflation from a supply shock.

 

[Ahlevah]

Seems like he was talking about QE2. My statment regarded QE1.

In October, 2008? I don't think so.

 

[washunut]

In October, 2008? I don't think so.

Well we are talking about Peter Schiff with Glenn Beck.

 

[Moot]

Perhaps we can have a thread that is less about who is evil and who is virtuous and more about macroecromics. I am not an economist but like many have an interest in the subject. The Fed has all but announced that because the economy has not reached full potential and inflation is running below their target they need to do more. They can't lower short term rates below zero so they will have another round of quantitative easing.

I wish they would just call QE for what it is, creating money out of thin air. Quantive easing is a measure of last resort meant to cause inflation. But if it doesn't work or should I say works too well, then there will be hyperinflation. And I haven't seen a good example of where QE has been a success, so it will be interesting.

For me, QE2 provides no incentive to save because the interest rates will still be low. And it doesn't provide incentive to spend because purchasing power will be diminished by the devalued dollar, hence inflationary spending. But a devalued dollar does help pay off debt, and since personal debt is at all time high, then maybe that is a good thing, eh?

It appears that the hope is to raise asset values including housing and exports. The latter will help exports to some extent so the hope is that translate into wage inflation, etc.

I thought the hope was to loosen up the banks reserves and liquid assets so they start lending again and consumers start borrowing again. So how does that translate into "wage inflation" when the unemployment rate is still high?

The Fed understands that there is a cost to this but hope that the benefit is greater than the cost. The reason I use the word hope is because this is pretty new ground for the fed at a time of a tepid recovery.

The problem with the Feds even announcing a price level target (PLT) for inflation is that if they don't meet their target then investors will lose confidence in the feds ability to control inflation. So the Feds have to be very careful what they say or even hint at, which made Bernakes last speech on Friday somewhat surprising when he said....

“FOMC participants generally judge the mandate-consistent inflation rate to be about 2 per cent or a bit below” and then added, " He then adds that with the underlying inflation currently at about 1%, “inflation is running at rates that are too low” .

To my knowledge that is as close to actually announcing a PLT that the Feds have ever come. So now the market has a high expectation that the Feds will pump more money into the economy and for inflation to rise 1% to meet the 2% inflation expectations. And the market is already reacting with higher gold prices and increased betting against the US dollar. But how is that going to stimulate the economy?

The flipside is that QE2 will in fact bring inflation, but that it will not be in the asset classes that the fed hoped for. An example being what we have seen the last 4-6 weeks with price increases in metals and grains which have not yet had a material impact on the final cost paid by consumers.

The market expectation is that QE2 is imminent, and it will be large and a boon to almost every asset class. But I don't know why the market thinks that when it is more likely going to be measured in small increments over a period of time to meet the 2% inflation target rate rather than one big influx. That could be next year or it could be three years, who knows really?

So what do you think. Will the Fed be able to revitalize or at least increase the price of houses. Will we get the wage inflation that the fed expects. Or will we get higher inflation but in undesired places. Higher oil and food costs, higher costs of imported goods with little or no wage inflation to offset it.

I hope so, but given their history, I don't have much faith in the large banks to do the right thing. And of course we all want our home values to go up, but unless wages go up with it, then who will have the money to buy homes? And IMO, it looks like business are trying to lower wages not raise them, so until the unemployment goes down, I just don't see how the value of homes will go up any time soon. I think the best we can hope for right now is some sort of stability.

 

[phattonez]

So quantitative easing is supposed to raise aggregate demand. Banks will probably get more money to lend. Say we all get a check for $600. Will we act based on what we perceive $600 is worth in current value, or what we perceive it to be in the future? More than likely we will act in accordance with its current value. So what happens when the inflation is realized? We have less money than we thought? We need to save more for protection and to get our time preference where we want it to be?

Quantitative easing does not deal with people's time preference. That doesn't change. So why don't we allow people to get back to their time preference? It would seem to me that more inflation would merely exacerbate this problem.

 

[phattonez]

Just some anecdotal evidence I'm presenting, but just interesting. There was some price inflation in 2009, so then why did consumption of these products go up?

Milk - United States Yearly Dairy, Milk, Fluid Domestic Consumption (1000 MT)

Corn - United States Yearly Corn Domestic Consumption (1000 MT)

Beef and Veal - United States Yearly Meat, Beef and Veal Domestic Consumption (1000 MT CWE) (consumption here decreased in 2008 when there was inflation but increased when there was deflation, interestingly enough)

Swine - United States Yearly Meat, Swine Domestic Consumption (1000 MT CWE) (same interesting trend as beef and veal)

Wheat - United States Yearly Wheat Domestic Consumption (1000 MT)

I understand that this is not a refutation of the proposed relationship between inflation and aggregate demand. Nonetheless, I think this lends credence to my argument that we need to look at relative prices and not a general price level. Furthermore, it seems that consumption can go up in some areas despite deflation. Overall consumption may have fallen, but I think that's more of a signal of a productive system that is out of whack with consumer demand. Production should match demand, not the the other way around.

 

[drz-400]

So quantitative easing is supposed to raise aggregate demand. Banks will probably get more money to lend. Say we all get a check for $600. Will we act based on what we perceive $600 is worth in current value, or what we perceive it to be in the future? More than likely we will act in accordance with its current value. So what happens when the inflation is realized? We have less money than we thought? We need to save more for protection and to get our time preference where we want it to be?

Well based on previous obsevations in the macro economy, as inflation is increased or "realized" output increases.

 

[phattonez]

Well based on previous obsevations in the macro economy, as inflation is increased or "realized" output increases.

When inflation is realized, people spend less of their total income proportionally. They try to save more to get their time preference to where they want it. During the inflation but before it is realized, yes production does increase because the available capital seems to increase. However it's not the case, and when that is realized what happens to capital markets?

 

[oldreliable67]

An interesting thread with lots of thoughtful posts. Reading it brings a couple of points to mind:

Inflation targeting is taking on some aspects never before made explicit at the Fed. While heretofore there has been general agreement and an implicit acknowledgment of some desirable minimum inflation rate, there has never been an explicit target inflation rate. While the FOMC minutes, as far as I know (and I've been away for a while, so I could have missed it), have yet to "officially" articulate it, the prevalent discussion seems to home in to 2% as the number. So how does the Fed know whether or not they are hitting or missing their target?

In the past, various Fed officials have often referred to such measures the Price Index for Personal Consumption Expenditures excluding Food and Fuel when referring to a 'core' rate of inflation. This seemed to be the favorite of Alan Greenspan when he was chairman. Now, however, attention is turning to the inflation measure estimated by the Cleveland Fed, or actually two of them, referred to as the "median CPI" and it's relative, the "trimmed mean CPI." The objective of these alternative measures is to provide a gauge that reflects the impact of monetary policy on inflation. How do they do this?

Both measures start with the same BLS information that produces the CPI. In the case of the Median CPI, the Cleveland Fed simply goes down the survey list, choosing the median response to the CPI survey and calculates a resulting inflation measure. According to research from the Cleveland Fed, the median CPI provides a better signal of the inflation trend than either the weighted-average-of-all-items CPI or the CPI excluding food and energy.

The "trimmed means CPI" measure excludes 8 percent of the CPI components with the highest and lowest one-month price changes from each tail of the price-change distribution results in a “16 percent trimmed-mean” inflation estimate.

The intent of both measures is to abstract from those price movements caused solely or principally by commodity-like supply and demand short-run volatility, while retaining the ability to track them longer-term, and produce measures that better reflect monetary policy actions.

Here is how Bernanke framed it in his most recent speech:

the FOMC has found it useful to frame our dual mandate in terms of the longer-run sustainable rate of unemployment and the mandate-consistent inflation rate. The longer-run sustainable rate of unemployment is the rate of unemployment that the economy can maintain without generating upward or downward pressure on inflation. Because a healthy economy must allow for the destruction and creation of jobs, as well as for movements of workers between jobs and in and out of the labor force, the longer-run sustainable rate of unemployment is greater than zero. Similarly, the mandate-consistent inflation rate--the inflation rate that best promotes our dual objectives in the long run--is not necessarily zero; indeed, Committee participants have generally judged that a modestly positive inflation rate over the longer run is most consistent with the dual mandate. (The view that policy should aim for an inflation rate modestly above zero is shared by virtually all central banks around the world.) Several rationales can be provided for this judgment, including upward biases in the measurement of inflation. A rationale that is particularly relevant today is that maintaining an "inflation buffer" (that is, an average inflation rate greater than zero) allows for a somewhat higher average level of nominal interest rates, which in turn gives the Federal Reserve greater latitude to reduce the target federal funds rate when needed to stimulate increased economic activity and employment. A modestly positive inflation rate also reduces the probability that the economy could fall into deflation, which under some circumstances can lead to significant economic problems.

Make no mistake about it: the Fed will do whatever it takes to prevent deflation and accomplish its mandates.

 

[phattonez]

Make no mistake about it: the Fed will do whatever it takes to prevent deflation and accomplish its mandates.

What is wrong with deflation considering that deflationary spiral is a nonsense concept?

 

[oldreliable67]

What is wrong with deflation considering that deflationary spiral is a nonsense concept?

Would you elaborate on why you think "a deflationary spiral is a nonsense concept?"

 

[washunut]

Just some anecdotal evidence I'm presenting, but just interesting. There was some price inflation in 2009, so then why did consumption of these products go up?

Milk - United States Yearly Dairy, Milk, Fluid Domestic Consumption (1000 MT)

Corn - United States Yearly Corn Domestic Consumption (1000 MT)

Beef and Veal - United States Yearly Meat, Beef and Veal Domestic Consumption (1000 MT CWE) (consumption here decreased in 2008 when there was inflation but increased when there was deflation, interestingly enough)

Swine - United States Yearly Meat, Swine Domestic Consumption (1000 MT CWE) (same interesting trend as beef and veal)

Wheat - United States Yearly Wheat Domestic Consumption (1000 MT)

I understand that this is not a refutation of the proposed relationship between inflation and aggregate demand. Nonetheless, I think this lends credence to my argument that we need to look at relative prices and not a general price level. Furthermore, it seems that consumption can go up in some areas despite deflation. Overall consumption may have fallen, but I think that's more of a signal of a productive system that is out of whack with consumer demand. Production should match demand, not the the other way around.

I am pretty sure that the fed is trying to inflate hard assets not foodstuffs. The thinking is if people expect housing for example to keep coming down then why buy now if you can rent. With food what you see if there is a spike in the cost of steak people tend to eat more chicken etc.

 

[phattonez]

Would you elaborate on why you think "a deflationary spiral is a nonsense concept?"

Do people buy computers even though they know that the technology will be outdated in just 2 years? Then how can you say that economic activity will stop during deflation beause the money will be worth more later?

 

[phattonez]

I am pretty sure that the fed is trying to inflate hard assets not foodstuffs. The thinking is if people expect housing for example to keep coming down then why buy now if you can rent. With food what you see if there is a spike in the cost of steak people tend to eat more chicken etc.

Inflation effects all products. You can't have inflation that only affects certain goods unless you affect the production of just those sectors.

 

[washunut]

Inflation effects all products. You can't have inflation that only affects certain goods unless you affect the production of just those sectors.

Totally agree. I am not in favor of trying to inflate.

 

[Moot]

Totally agree. I am not in favor of trying to inflate.

And yet, almost all economists agree that a small rise in inflation may be the only way out of this recession. Especially if it forces the banks to loosen up their liquidity and start lending again. Hence, Bernake trying to remove some of the uncertainty in the market, since that is what investors claim they are worried about. Now they know, there will be a QE2 sometime after the election and they can plan where to start investing again. The amazing thing is, the Feds may not have do much QE2 since the market is already reacting to just the mere mention of it. Which kinda shows just how much power the Feds have really have, doesn't it? But there is one other thing that is creating uncertainty in the market and that is the expiration of the Bush tax cuts on Dec. 31.

 

[washunut]

And yet, almost all economists agree that a small rise in inflation may be the only way out of this recession. Especially if it forces the banks to loosen up their liquidity and start lending again. Hence, Bernake trying to remove some of the uncertainty in the market, since that is what investors claim they are worried about. Now they know, there will be a QE2 sometime after the election and they can plan where to start investing again. The amazing thing is, the Feds may not have do much QE2 since the market is already reacting to just the mere mention of it. Which kinda shows just how much power the Feds have really have, doesn't it? But there is one other thing that is creating uncertainty in the market and that is the expiration of the Bush tax cuts on Dec. 31.

There are a lot of things causing uncertainty in the markets. While health care and fin reg bills have passed. These bills have many regulations that still are yet to be written. Also would you put a lot of money in a long term asset in America until you understood the status of the dollar, and the strength of the recovery?

As to inflation, you are correct many economists would like a little inflation. Even those folks admit that they can't be sure once you let the inflation genie out of the bottle you can stop it when you want to.

 

[Missed AB]

For me, QE2 provides no incentive to save because the interest rates will still be low. And it doesn't provide incentive to spend because purchasing power will be diminished by the devalued dollar, hence inflationary spending. But a devalued dollar does help pay off debt, and since personal debt is at all time high, then maybe that is a good thing, eh?

This is a HUGE misnomer, and I really wish people would understand what they are thinking when they write or say this. If you have debt, inflation will make paying back that debt harder. If your job is most similar to most people's jobs, then your paycheck is not tied to inflation. The gas to drive to work costs more. The food costs more. Clothes cost more... If you have debt tied to anything with a variable interest rate then as inflation goes up so to do the interest rates and minimum payments.

So with inflation, you money goes LESS FAR. Your minimum debt repaymets go up while covering the same principle balance.

The way inflation helps pay back debts is if YOU are the one prining the money, ie the Fed can pay back it's loans with cheaper money.

Or you have large investments in inflation hedges which you can sell at a later date to pay back debts. Chances are if you own large lots of gold, oil, gas, or you are short gov't bonds, you probably don't have too much debt on your balance sheets.

 

[Missed AB]

And yet, almost all economists agree that a small rise in inflation may be the only way out of this recession.

Then most of those economists are morons. The way out of the recession is with jobs. Inflation is an effect of a growing economy not the cause of a growing economy! Supply and demand dictate price. If prices are going up in a stable economy it is because of demand not because the currency is being devalued.

Especially if it forces the banks to loosen up their liquidity and start lending again.

Debt... the reason we are here today discussing the economic events of recent times. Read above.

Bernake trying to remove some of the uncertainty in the market, since that is what investors claim they are worried about. Now they know, there will be a QE2 sometime after the election and they can plan where to start investing again.

Yes, now that there is some clearity, other currencies, stocks outside the US market, commodities, and long term short US gov't bonds. Not winning me over to anything that will bring this economy roaring back.

the Feds may not have do much QE2 since the market is already reacting to just the mere mention of it. Which kinda shows just how much power the Feds have really have, doesn't it?

Just holding the EU currency in your wallet over the past 3 months would have yeileded a 10% return on investment VS the USD. Investing that same money in the ETF DIA which tracks the DJI average would have yeiled you about 6% return on invesment over the same time period. So basically if you were a european investor, you lost 4% of your invesment because of our monitary policy. Why would anyone want to invest in that environment? How does that help with the current state of the economy or your retirement prospects?

... there is one other thing that is creating uncertainty in the market and that is the expiration of the Bush tax cuts on Dec. 31.

That's what it's all about :/

 

[Moot]

This is a HUGE misnomer, and I really wish people would understand what they are thinking when they write or say this. If you have debt, inflation will make paying back that debt harder. If your job is most similar to most people's jobs, then your paycheck is not tied to inflation. The gas to drive to work costs more. The food costs more. Clothes cost more... If you have debt tied to anything with a variable interest rate then as inflation goes up so to do the interest rates and minimum payments.

So with inflation, you money goes LESS FAR. Your minimum debt repaymets go up while covering the same principle balance.

The way inflation helps pay back debts is if YOU are the one prining the money, ie the Fed can pay back it's loans with cheaper money.

Or you have large investments in inflation hedges which you can sell at a later date to pay back debts. Chances are if you own large lots of gold, oil, gas, or you are short gov't bonds, you probably don't have too much debt on your balance sheets.

Just because you disagree doesn't mean people don't think when they write these things any less than you do. So lets just try to have a nice conversation and leave the personal accusations out of the equasion.

Debt does not rise in value as the dollar devalues. In notional terms, debt is a contracted amount in former-dollar-value IE: bonds, mortgage loans, car loans, small business loans, etc. Thus, if we suddenly hand several hundred thousands of dollars to each and every household, a dollar would become worth 50 cents in real terms, but in debt terms, it will still be worth a dollar, and people will have more of them. Which means paying down a debt whose value hasn't changed with cheaper money is a very crafty and effective way to pay down debt, especially the national debt.

Why do you think countries that own our debt get nervous when we devalue our dollar? It's because we will be paying off a debt whose value hasn't changed, but with new devalued cheaper money. Which is good for the debtor (us), and bad for the creditors (bond holders). But since our national debt is public debt and if not paid down, then we as a country run the risk of defaulting on our debt and I don't think our creditors would want that, because then they would get nothing and we would lose investor confidence.

As for the public, we have a choice, we can have our taxes raised in order to pay down our public debt or we can let the Feds devalue our money. And in this current political climate, no politician has the guts to raise taxes, so the people have unwittingly made their choice; devalue the currency.

You also mentioned wages weren't tied to inflation, well its true, wages have not kept up with inflation for the last ten years or so, which is why so many working people are in debt up to their eyeballs just trying to keep up with inflation. But wages used to be and should be tied to inflation, since wages are the real nominal purchasing power of the economy. So a devalued currency would essentially put more money in peoples pockets to help pay down some of their existing personal debts and since the cost of goods and services would likely go up, it would give them incentive to spend more wisely. I think the people inflation would hurt most are those living on fixed incomes, seniors.

In OldReliables post, he mentions that the Feds will be using BLS as their new CPI indicator. Which I take to mean that wages are tied to inflation. I would also note that Bernake seems to think that unemployment is more cyclical rather than structural as many other economists seem to think. So I take that to mean that the Feds will be studying BLS figures to determine the volitle short term and long term effects of their not so explicit, explicit inflationary CE2 monetary policy.

 

[Moot]

Then most of those economists are morons. The way out of the recession is with jobs. Inflation is an effect of a growing economy not the cause of a growing economy! Supply and demand dictate price. If prices are going up in a stable economy it is because of demand not because the currency is being devalued.

Yes supply and demand can dictate price, but so can herd mentality, irrational exuberance, market manipulation, monopolies, and access to credit.

Also, there are some who argue whether supply creates the demand or whether demand creates the supply. But thats probably a discussion that needs a thread of it's own.

Debt... the reason we are here today discussing the economic events of recent times. Read above.

No, some of us are just interested in how things work and how it effects us personally. I can't do much about the national debt except complain and I don't have any substantial personal debt to complain about. My interest is mainly to try and understand what the market is going to do so I can try to protect what I have. Fore warned is fore armed, so to speak.

Yes, now that there is some clearity, other currencies, stocks outside the US market, commodities, and long term short US gov't bonds. Not winning me over to anything that will bring this economy roaring back.

The economy is never going to roar back, instead it's probably going to limp along slowly gaining momemtum over the next couple years with many ups and downs inbetween.

Just holding the EU currency in your wallet over the past 3 months would have yeileded a 10% return on investment VS the USD. Investing that same money in the ETF DIA which tracks the DJI average would have yeiled you about 6% return on invesment over the same time period. So basically if you were a european investor, you lost 4% of your invesment because of our monitary policy. Why would anyone want to invest in that environment? How does that help with the current state of the economy or your retirement prospects?

People want to invest in the US because we still have a huge vibrant economy to back up our debt. IMO, what effects the current state of the economy is irrational expectations, near zero interests rates, market manipulation and the political climate. All of which have or will soon have an effect my retirement prospects.

That's what it's all about :/

Hard to say if tax cuts are what it's all about considering there are always other variables to consider.

 

[Moot]

There are a lot of things causing uncertainty in the markets. While health care and fin reg bills have passed. These bills have many regulations that still are yet to be written. Also would you put a lot of money in a long term asset in America until you understood the status of the dollar, and the strength of the recovery?

America is still a huge and vibrant market that foreignors can not ignore, so yes, I would still invest in America no matter the strength of the dollar. With the pending Feds QE2, I just wouldn't invest in bonds right now and put most of my money in equities instead. Because if inflation does stimulate the economy and if I want my money to keep up with inflation, then equities is where I think my money should be. But it's like trying to beat the crowd before demand pushes prices up because everyone else is probably doing the same.

As to inflation, you are correct many economists would like a little inflation. Even those folks admit that they can't be sure once you let the inflation genie out of the bottle you can stop it when you want to.

Yeah, it's kinda scary because the last thing we need is hyper-inflation. So lets hope the Feds don't blow it, but I don't anticipate they will.

 

[phattonez]

And yet, almost all economists agree that a small rise in inflation may be the only way out of this recession.

Alright! Appeal to popularity! That's the way to do it!