Steve Keen on QE

     As Keen notes, the subject of the impact of QE is fraught with controversy.

     "America is a land of contention, and one of the most contentious topics here (I’m in Seattle as I write) is the impact of the Federal Reserve’s policy of “Quantitative Easing” – otherwise known as ‘QE’. The Federal Reserve has committed to spending $85 billion every month buying a wide range of bonds from banks, until such time as the US unemployment rate falls below 6.5 per cent."

    "The Fed has implemented this policy because it believes it is the best way to stimulate demand in a depressed economy. Its critics oppose it because they believe this massive amount of ‘money printing’ must inevitably lead to ruinous inflation."

     "I reckon they’re both wrong, and in a seriously wonky post I’ll try to explain why, using my modelling program Minsky."

    http://www.businessspectator.com.au/article/2013/5/27/economy/qe-quantitatively-irrelevant#ixzz2UktNyVvg

    This Minsky model doesn't get much respect from Noah Smith who insists that NK models-while maybe having some flaws of their own-are nevertheless light years ahead of Minsky. 

     "DSGE models are MUCH better than Keen's models, in terms of fitting the data, forecasting...you name it."

    "That doesn't mean DSGE models are useful (see earlier post), or well-specified (they're not). It just reflects on how totally useless and unconnected to data Steve Keen's models are."

     http://noahpinionblog.blogspot.com/2013/05/what-does-it-mean-to-have-predicted.html

   There is some truth in Noah's argument that Keen made his predictions in 2007 before he had the Minsky model:

   "I think he argues he knew a depression-like crisis was possible because:

a) He considered the Efficient Finance Hypothesis to be complete nonsense.

b) He considered rising private debt to be a problem, unlike "neoclassical" models.

c) He considered the non-neutral nature of money.

d) Once the crisis hit, he was confident the money multiplier was a textbook myth."

   "Ahh, but how did he get from those beliefs (a-d) to the conclusion that a depression-like crisis was possible?"

    "He certainly didn't do it by making a model, because the "crises" in his model don't look anything like the Depression.

     Regarding QE, Keen makes the argument that it doesn't actually create money. 

     "So the ‘printing money’ moniker that critics give to QE is misguided: it actually creates no additional money at all (outside of the gain banks will make on the repo deal). For money to really be created, QE would have to go directly to the Deposits of the public in the private banks, and that’s not what QE does. ‘Printing Money’ is therefore a false model: it implies that Ben Bernanke is printing greenbacks and mailing them in little brown envelopes to everyone on Main Street, and that’s not even close to how QE operates.

But the critics of QE aren’t the only ones operating with a false model: so is the Fed. I’m sure that Bernanke knows that QE isn’t creating additional money, but he believes that it will reduce interest rates and thus encourage more lending by the private banks, which would stimulate demand. He sees no problem with more debt being taken on by the public, since he thinks that the level of private debt has no impact – good or bad – on the economy. From his “New Keynesian” point of view, a loan is simply a transfer from a saver to a borrower, and, as he put it in 2000: “Absent implausibly large differences in marginal spending propensities among the groups … pure redistributions should have no significant macro-economic effects…”

     Keen then puts up a chart that shows that the the country still has way too much private debt. He argues that when a bank lends you money it isn't just like when private individuals lend between each other-in that case there is a pure redistribution. However, when a bank lends you money, your spending power goes up without reducing anyone else's. 

    So it's not a pure redistribution with no macro effect as demand rises. So Keen's argument is that AD is income plus the change in debt. As the country still owes way too much private debt, QE can't have the impact that Bernanke hopes-his hope being that low interest rates will spur lending. 

    "As I’ve explained at length before, this is why ‘the Great Moderation’ occurred – because Americans borrowed up big from 1993 till 2008, increasing private debt from $10 trillion to $40 trillion when GDP rose from $6 trillion to $14 trillion. It’s also why ‘the Great Recession’ occurred – because when Americans stopped borrowing and instead started to reduce their debt, demand (for both goods and services and assets like houses and shares) collapsed."

    "So contra Bernanke’s belief that the aggregate level of private debt doesn’t matter, it matters a great deal. That in turn means that Americans are very unlikely to spend more because of QE, because they’re already straining under a level of private debt that is unprecedented – even after several years of deleveraging, the level of private debt compared to GDP is higher than it ever was during the Great Depression."

     It's a persuasive case it seems to me-that private debt is hurting demand. He argues that-assuming it doesn't do much good as he does- QE is not merely harmless as it juices up asset markets and leads to bubbles in stocks and commodities-which enriches the already very rich but does little for the little guy who may suffer from "relative inflation" in the price of food and gas. 

    The part about the debt overhang makes sense. Yet, the economy really does seem to be getting stronger. As to bubbles, we see equities continuing to rise, but not so much commodities. In fact we see oil actually dropping which is more relief for the little guy. 

    Over the last 10 years we've seen a pretty clear correlation between rising oil and gas prices and a rising economy. For the first time in a long time over the last year we've seen this relationship change. So right now, ironically, the empirical picture doesn't wholly favor Keen's heterodox view. I'm certainly not claiming that I see anything definitive about the impact of QE. However, it is clear that the market loves it, but that the real economy is improving as well. Keen doesn't even mention that in his piece.