Monetary PolicyGuy Conger
The QE 1,2 and 3 series, by creating vast sums of new money, coupled with artificially low interest rates, has injected capital into the equity markets and thus raised stock prices. This is seen as a major victory by the Keynesians.
The trick will be how the FED (eCB, BofJ) can withdraw these funds if interest rates begin to raise. The world is awash with newly created money, most of it being held either privately (corporations, companies, and individuals) or governments (held because of future risk.) The only way open is for the FED to begin to sell government securities thus drawing money back into the FED where it can be sterilized (if possible, that will depend upon the immediate demands of the federal debt picture.) However, attracting potential buyers of new government debt will depend upon the interest rate offered, and now the picture becomes murky. Most government debt is now short term, and must be rapidly turned over, increases in the interest rate means the cost of that debt will skyrocket upwards, meaning the government must again raise taxes or borrow more from the private markets at exactly the same time that it is trying to draw down their capital reserves through new purchases. These amounts are staggering in size.
As Maultin and Tepper note, in “Endgame”, there are only a few options. One is, of course inflation. That may sound strange because of the deflationary influences that have gripped most world economies. But with the exception of Japan, most deflationary periods have ended within a reasonable amount of time, and if the world is awash with newly created money, that money will go somewhere. If we inflate we must also realize that enormous sums of American money is held overseas. If inflation causes that money to lose value those cash-holders will not continue to hold their reserves but will flood the world with it, thus causing even more inflation.
We must also remember that debt, after a certain point, reduces growth. It does so in private life as well as corporate bodies and governments. “This Time It Is Different” empirically explores the relationship of governmentally held debt with growth rates. Their conclusion is that at near 100% debt to GDP growth suffers a 1% diminishment, thus the traditional 2.5-3% growth rates goes down to 1.5-2%.
So we have entered into a new economic world, one our country has never encountered. We have largely followed the Keynesian game-pan, not just in the U.S. but in Europe and Japan, and the result is clear.