To Explain Why Quantitative Easing Will Be Reversed

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718

The short answer is because inflation. The longer answer is because maybe inflation.

Just so we’re clear on that.

As to why, it’s all rather simple. Quantitative easing is the process of creating new money to go buy government bonds. Whether it’s just to buy some bonds to lower long term interest rates, or it’s to buy the bonds that are funding some hundreds of billions of government spending doesn’t really matter for the point of the argument here. At some point it’s highly likely that QE will have to be reversed. The bonds sold back to the market, the money taken back into the Bank of England and there destroyed.

This has implications – one of which is that yea, even those bonds held by the Bank of England (or, if you prefer, the Federal Reserve) are still part of the national debt. Even only contingent liabilities are still on balance sheets, right?

So, note the caveat being applied here. If we start to have inflation then we’re going to have to do something about QE. Reverse it that is. This depends upon MV=PQ.

Yes, I know Milton Friedman liked it but it is still true. It’s an identity. Money times velocity is equal to prices time quantity. Or, more colloquially, the amount of money times the number of times money is used is equal to the price of things we use money for times the quantity of things we use money for.

OK.

We can also think about this in a slight different and not wholly, 100% and accurate manner. M is narrow money, M0 or M1 in the usual listings. Multiply that by V and we get wide money, M4 and possibly further out than that. That’s not right, but it’s useful as a description.

Inflation depends upon some version of wide money, not upon narrow money. That’s gotta be true because we do know that if we had this much money around – this post-QE amount – 15 years ago we’d have had stonking inflation. Something’s changed and V is it. It’s M0 that has soared here, not M4, which is why we’ve much more money without the inflation – it’s the wide money that matters.

OK. So, this is American but still useful:

And one more:

And more:

Note that this isn’t accurate. But it’s good enough as an example. Our contention, in fact our identity, is that the first one, M, time sthe second one, V is MV. Or, narrow money times velocity is wide money. And that it’s the wide money that matters for inflation.

So, If that V stays where it is forever then sure, we don’t need to do anything about M0 or M1 and this QE can just carry on as it is – not that doesn’t mean more of it, just that we don;t have to sell those bonds.

OK, so, hands up everyone who thinks that we’ve nailed it so that V never rises again? You know, like it did for decades?

Well, yes, and there’s our problem, isn’t it? If the economy and the relationship with the amount of money in it – that V – ever returns to something like it was 10 years ago, or even 1 year ago, we’ve quite an inflationary problem stored up, don’t we?

Which is exactly why we do need to treat the QE debt as part of the national debt. QED. Even if we want to say that it’s not a debt in the strictest sense of the word it’s still a contingent liability.

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Spike
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Spike

Your text rendition of this is indeed a tautology. Your equation is silly, as the unknowable “V” is what we call a fudge factor. Decades of unrestrained gov’t spending without inflation? Ah! the money must have simply slowed down, though we can’t measure it, as none of the banknotes have speedometers on them. Not that I have a better explanation.

I used to credit Obama with masterfully wrecking the economy exactly as fast as he wrecked the dollar, but Trump was no master, and deliberately goosed the wage scale, mostly by curtailing options from Mexico. But still not much inflation.

Quentin Vole
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Quentin Vole

There’s some truth in that, but I’d say that Velocity of Money is simply defined by that equation. We know there’s such a thing – just considering hard cash, some of what I draw from an ATM gets spent almost instantly, some stays in my wallet for a while (months at the moment!) and some small coins may be placed in a jar in the bedroom and stay there for years. The easiest way to measure the velocity is from the equation, so that’s how we do it.

Spike
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Spike

Yes, that’s intuitive, the coins in the jar cannot affect the general price level (except that you bid up prices more aggressively knowing you have additional coins in the jar).

But here is a companion equation: SV=T. S is the rising sea levels, T is the traffic on Twitter. V is velocity and is chosen to make the equation hold. As you say.

john77
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john77

Tim is stating an accounting identity. It is easier to understand if you pretend that we only use coins but it remains true with “broad money”.
GDP is the total amount spent by everyone on everything in the economy. If there are £M of coins and the weighted average number of times each changes hands in a year is V then the total amount spent by everyone on everything is £MxV, which therefore mean GDP=MxV.
We don’t keep a record of V by counting the number of times each coin changes hands but we do estimate it by dividing GDP by M.

Craig
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Craig

There is of course one problem with the central bank selling the assets it bought on the open market. Who will buy them? Now there is a price at which those assets can be sold, but to attract the capital necessary the central bank might very well need to sell those assets at increasingly greater discounts. In essence they would be raising the interest rates and as they did that…pop pop goes the bubbles the bubbles…….asset prices will decline. Indeed the government could very well contribute as well and simply tax money and destroy the money itself. Right now? They… Read more »

Spike
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Spike

Laffer’s napkin strongly suggests that Biden cannot fund his plans by raising tax rates. Nor can he by printing money. This not only tanks the values of gov’t-owned assets but sparks inflation and balloons the cost of servicing and rolling-over existing debt.

Spinelessness has gone on for decades under both parties, but we have had what Kudlow calls entrepreneurs’ “animal spirits.” Now we will have a President who doesn’t know what anything is for and treats achievement as a national scourge.

Wheels
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Wheels

According to Tim, in the US, the Laffer peak is around 70% so state, federal and social security combined and you still have 10-15% to go before you peak.

Spike
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Spike

Oh, I don’t believe that. But I’ll make a narrower claim: Biden won’t find the money he expects, raising tax rates.

Esteban
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Esteban

Pretty sure that’s been true of damn near every tax hike in recorded history, the expected increase in $ always falls short. Bigly. Kind of like the amount of traffic on the new choo choo line that was supposed to self-supporting.