Sunday, 5 August 2012

Nine reasons why QE is a farce.

1. The purpose of QE and interest rate reductions is amongst other things to encourage investment, which in turn would boost aggregate demand (AD). However, in a recession – certainly at the START OF a recession, there is a SURPLUS of capital equipment! Trying to encourage the production of capital equipment in that scenario is raving bonkers.

2. There is no reason whatever to think that because there is a recession, that the OPTIMUM ratio in which different factors of production ought be employed has changed. In particular there is no reason to think ratio “capital equipment to labour and materials” ratio will have changed. Thus there is no reason to skew demand toward investment rather than towards the employment of labour, materials, hair dressers, computer programing, or anything else.

Indeed, the latter point would seem to be a mile above the heads of the pro-QE brigade since, far as I can see, they’ve never even raised the point.

3. It is common for employers to make a 20% or even 100% profit on a capital investment, or indeed a 20% or 100% loss. Thus, interest rate changes of two or three percent are irrelevant. Same goes for the small change in the availability of funds to borrow that stems from QE.

Or as Keynes put it, “I am now somewhat skeptical of the success of a merely monetary policy directed towards influencing the rate of seems likely that the fluctuations in the market estimation of the marginal efficiency of different types of capital...will be too great to be offset by any practicable changes in the rate of interest." Keynes’s General Theory – near the end of Ch 12. (h/t to skeptonomist).

4. Short term government bonds and cash are near enough the same thing. That is, QE, in that it involves purchasing short term debt is about is fatuous and central bank offering $100 bills in exchange for $20 bills, or vice versa.

5. An investment is a LONG TERM commitment. Revelation of the century that, isn’t it? Thus those making investments (whether firms or families buying a house) are not greatly concerned about SHORT TERM rates. It’s LONG TERM rates that interest them.

We are five years into a recession, and the Fed seems to have only recently worked this one out in that it is only recently they’ve gone for “operation twist”: an attempt to influence long term rates.

6. You think there is a relationship between central bank rates and the rates charged by credit card operators? Sorry: there is no relationship according to this study.

Thus QE will presumably have equally little effect on credit available from card operators.

7. This attempt by the Bank of England to explain QE is a farce. It sets out several reasons as to why QE might work. But it does not say that any of them “would” or “will” work and for reasons based on empirical evidence. It simply says that the various transmission mechanisms “might” work.

8. Radcliffe commission which studied monetary policy in Britain decades ago concluded that ‘there can be no reliance on interest rate policy as a major short-term stabiliser of demand’. So presumably the same goes for QE.

9. An important (if not THE most important) cause of weak demand at the moment is private sector deleveraging: i.e. the desire by private sector entities to pay off debts and/or accumulate cash. That is, the private sector is trying to increase its stock of net financial assets. QE has virtually no effect on the private sector’s stock of net financial assets.


We’d be better off with Laurel and Hardy running central banks with the Marx Brothers, Bart Simpson and Rosanne Barr in charge of governments. 


P.S. (9th Aug 2012) A possible justification for QE (and/or interest rate reductions) is that the lag between the decision to implement and the desired effect is shorter in the case of monetary policy than fiscal policy. Unfortunately the evidence seems to be that lags are not spectacularly short in the case of monetary policy. E.g. see this Bank of England paper.

P.S. (27th August, 2010). To add insult to injury, a recent Bank of England report on QE says that the lion’s share of the gains from QE went to the richest 5% of the population. Well surprise surprise: some of us predicted that when QE was first mooted.

P.S. (14th Sept 2012). It should be said that QE does have one small saving grace. That is that it is not 100% clear what the crowding out effects of fiscal policy are, and if the effects are significant, then QE nullifies those crowding out effects. But that’s a two edged sword: that is, the latter point is as much a criticism of QE as it is praise. As I’ve been pointing out for years, if the crowding out effects of fiscal are unclear, it’s daft to employ fiscal stimulus alone. Much better is to employ fiscal and monetary in tandem, i.e. print money and spend it into the economy when appropriate, as advocated by Modern Monetary Theory and in this work by Positive Money, Richard Werner and the New Economics foundation.

P.S. (15th Sept 2012). Reason No.10. In boosting asset prices, QE partially insulates those who have made silly investment decisions against full consequences of their silliness. The effect is to encourage asset price speculation and asset bubbles in the future. (h/t to Positive Money).

P.S.  (25the Oct 2012). Also this article, which seems to be well researched, claims the UK authorities have no idea where QE money actually went.



  1. Couldn't agree more. And I don't think Friedman would agree with the current use of QE, either. We have reached the limits of monetary policy.

    1. Hi Frances,

      Yes, it’s now blindingly obvious to everyone (apart from central bankers and senior politicians) that monetary policy has reached its limits. I was actually saying more than that: i.e. that monetary policy should not be used in preference to fiscal.

      Re whether Milton Friedman would have approved, actually I think he might have. He approved of QE for Japan, as this article makes clear:

      As to what Friedman’s basic message was on money, I’m confused as are others. There is an article out there by Krugman (which I now can’t find) saying that Friedman was less than 100% clear as to what his basic message was.

  2. Agreed to all that, fair summary.

    One question: how come outside observers like thee or me, looking at this rationally can work all this out but the Powers That Be seem to believe in it? We can only assume that they are totally stupid (unlikely) or that they are totally corrupt (quite possible).

    1. Lewis Spitz, Professor of History at Stanford University had part of the answer. He said, ”Academicians are notoriously sensitive litmus paper reactors to current trends. The going mantras in the halls of academe are political correctness, demeaning to many individuals of both genders….” I.e. the elite, including the academic elite, are strongly influenced by fashion. Every group has its customs, rules, fashion.

      Put another way, emperors carry on wandering around with no clothes on long after every little boy has spotted the fact.

    2. Nah. It's simple. 'They' are self serving headless chickens. Once they admit all this then it's curtains for them.

    3. It's called the herd instinct. It is what bankers and punters thought 'house prices only go up' so huge loans, look where that got us. It will take a brave politician / leader to stand in the way and say that a change is needed. Until then we will bump along the bottom like Japan.

  3. I'd add a similar but different point, borne out of recent bitter experience.

    Central bank rates (and by extension QE) have very little to say about the cost of loans for small businesses, once we get below 5% or so.

    Which is to say, loan costs are basically the same as before the crisis for small businesses, except with more strings attached, largely designed to persuade directors that borrowing right now is a bad idea...

  4. Quote: "We’d be better off with Laurel and Hardy running central banks with the Marx Brothers, Bart Simpson and Rosanne Barr in charge of governments.".

    Don't forget Peter Griffin and Stewie, although Stewie actually really would have more brain power than all the western governments put together.


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