Sunday, November 21, 2010

Is QE2 a Ruse by Bernanke?

I recently sent Jeffrey Rogers Hummel, a Research Fellow at the Independent Institute, Associate Professor of Economics at San Jose State University, and one of the top Fed watchers in the country, a link to Federal Reserve Chairman Ben Bernanke's recent comment that he was not conducting "quantitative easing".

With permission, I reproduce below Jeff's comments. In them, he writes that QE2 may be a ruse. Since Jeff is one of the few who understands what really went on with QE1 (His upcoming  paper on  "Friedman versus Bernanke" will blow away the thinking that the explosion in the monetary base in late-2008 to early 2010 was all about Fed money expansion.), his thoughts can not be taken lightly.

At this point, my view is that Bernanke is doing a full out money blast that will translate into huge price inflation, however, the confirmation, as Jeff states, will be in the numbers. If Bernanke drains from other parts of the balance sheet to sterilize his Treasury asset purchases, then Bernanke is indeed pulling a fast one on the country. The numbers will tell all.

Here are Jeff's comments:
Thanks so much for sharing this Bernanke quotation with me, which I hadn't yet seen. It partly confirms what I had suspected from the outset: QE2 is a ruse.

Bear in mind that the Fed's announcement of November 3
said nothing about "quantitative easing" or even increasing the base.Rather it merely said the Fed was going to buy $600 billion in long-term Treasuries. If you look at the Fed's balance sheet, over the two weeks since the FOMC meeting, it has acquired about $30 billion of additional Treasuries. But that has been offset by a $13 billion fall in its holdings
of mortgage-backed securities plus more modest declines in other assets including foreign currencies and Maiden Lane, so that there has been almost no net effect on the balance sheet or the monetary base.

And now Bernanke denies that the term QE applies. As I argue in my "Bernanke vs. Friedman" paper, Bernanke's first alleged quantitative easing turned out to be no such thing, given that the Fed expanded its balance sheet (and the base) by explicitly borrowing a big chunk of the money and implicitly borrowing the remainder through paying interest on
reserves. Bernanke appears to be attempting something similar again--centrally allocating credit and manipulating the structure of interest rates WITHOUT affecting the money stock.

So why hasn't he been more straight-forward about this? One, because he wants to increase inflationary expectations, and all the talk about QE2 will help do that without any actual QE. Two, as suggested here (,he is really trying to induce more private lending by banks.

Yes, it could all blow up in his face. But right now, I don't see much danger of inflation. In any case, we will know more after the Fed releases the FOMC meeting minutes on November 23, as well as see what happens to the Fed's balance sheet over the next few weeks. If my suspicion continues to be confirmed, I will blog about it at Liberty & Power..


  1. Wenzel with a big scoop, once again! Where's the WSJ and the Bernanke-mouthpiece WaPo on this one? Did the NYT go bankrupt already, I've heard nothing from them?

  2. It all goes back to the question: ¿Will Bernanke be able to pull back?

    My guess: Absolutely not.

  3. Crazy, perhaps Bernake is smarter than we all thought.

  4. How did the "Fed expanded its balance sheet (and the base) by explicitly borrowing a big chunk of the money"???

    I understand how they borrowed the remainder by paying interest on reserves... but how did they explicitly borrow?

    Also, if he is "trying to induce more private lending", won't that be inflationary?

  5. @Anonymous

    Good question. Hummel details this in is upcoming paper,it was done in a couple of odd ways, but Hummel has it nailed.

    My guess as far as inducing the private lending is concerned is that Hummel is thinking it will be unsuccessful.

    My view is that it is likely to occur and be very inflationary.

  6. I found his paper, it is interesting.

  7. RW, does Hummel also have Greenspan nailed? :)

  8. Professor Murphy, Mises Daily is needed to clear this up.

  9. I second the Anonymous above. More clarification is needed on this issue. Particularly, I'd be interested in the explanation how "centrally allocating credit and manipulating the structure of interest rates WITHOUT affecting the money stock" would case price inflation/deflation.

  10. I thought that the Fed was going to recycle maturing mortgage debt into Treasuries over and above the $600bn QE2.

    I would expect Bernanke to at least have some plan to neutralise the inflationary effects of QE2 if required, such as raising the rate paid on excess reserves.

    His real problem is he needs to do an awful lot of funding, not only for the Federal government, but also for the rescues coming up in the lift. Obama can't do it, so the Fed must. And he must keep interest rates low, otherwise everyone is bust.

    The bond markets will not cover the deficit at current rates.

  11. With interest rate targeting, higher expected inflation causes the quantity of money to rise. Market forces--increases in the demand for loanable funds and decreases in the supply of loanable funds--put upward pressure on market interest rates. The central bank then creates more money to keep interest rates from rising. The result is increased money expenditures on output, and ceteris paribus, a higher price level. Of course, Bernanke hopes that firms respond to the increased volume of sales by producing more and employing more workers as well as raising prices.

    The only reason I can think of as to why the Fed wouldn't want to actually do quantitative easing (which Hummel assumes they don't want to do,) would be interest rate risk on their asset portfolio.

    My reading of the Fed announcement is that they will replace mortgage backed securities as they come do with treasury bonds. And then they will buy 600 billion more. I take it to be a target (very tentative) of base money to be $2.6 trillion. Hummell says no.