Paul Krugman thinks we need more QE. Not just a little bit more. About 8-10X more than current projections! Richard Koo’s head must be spinning. No, no, we haven’t failed, it’s just that we haven’t tried hard enough! Krugman’s idea is the equivalent of a shopkeeper who thinks he can scream about the loads of new apples he is putting on the shelves while creating a stir in the marketplace that will ultimately result in higher sales. It won’t work in the long-run.
Of course, this is all very ironic given Mr. Krugman’s most recent commentary regarding Mr. Bernanke’s lecturing of Japanese officials:
“American officials used to lecture other countries about their economic failings and tell them that they needed to emulate the U.S. model. The Asian financial crisis of the late 1990s, in particular, led to a lot of self-satisfied moralizing.”
Mr. Krugman used to lecture the Japanese quite a bit. In a 1999 piece Mr. Krugman discussed the ways in which QE could help the Japanese economy. He wrote:
“Quantitative easing: There has been extensive discussion of “quantitative easing” , which usually means urging the central bank simply to impose high rates of increase in the monetary base. Some variants argue that the central bank should also set targets for broader aggregates such as M2. The Bank of Japan has repeatedly argued against such easing, arguing that it will be ineffective – that the excess liquidity will simply be held by banks or possibly individuals, with no effect on spending – and has often seemed to convey the impression that this is an argument against any kind of monetary solution.”
The Bank of Japan not only thought QE would be ineffective - they actually admitted as much (see here). Mr. Krugman goes on to argue that QE is essentially a non-event:
“It is, or should be, immediately obvious from our analysis that in a direct sense the BOJ argument is quite correct. No matter how much the monetary base increases, as long as expectations are not affected it will simply be a swap of one zero-interest asset for another, with no real effects. A side implication of this analysis (see Krugman 1998) is that the central bank may literally be unable to affect broader monetary aggregates: since the volume of credit is a real variable, and like everything else will be unaffected by a swap that does not change expectations, aggregates that consist mainly of inside money that is the counterpart of credit may be as immune to monetary expansion as everything else.”
There’s an obvious caveat thrown about in here – expectations. Mr. Krugman seems to believe that we can talk inflation into the economy:
“But this argument against the effectiveness of quantitative easing is simply irrelevant to arguments that focus on the expectational effects of monetary policy. And quantitative easing could play an important role in changing expectations; a central bank that tries to promise future inflation will be more credible if it puts its (freshly printed) money where its mouth is.”
The bigger problem here is not quantity, however. Mr. Krugman appears to believe that the apple (and no, this apple salesman is not selling iPads unfortunately) salesman can rush into the marketplace and scream and wave his hands regarding the new stock of apples he has that is 10X larger than his old stock. “Step right up ladies and gents! Fresh new apples right off the truck! We’ve got 10X more than we had yesterday!”. The problem with this thesis is that, while it might cause a stir in the marketplace (it might even cause a near-term boost in sales – or commodity and equity prices if you will), ultimately, sales will be determined by the willingness of the consumers to purchase. Therein lies the weakness in QE. Because it does not alter net financial assets in the private sector there is no reason to believe that it will alter the real economy in the long-term.
Talking a big game about future inflation expectations is great and all, but talk is cheap. Ultimately, we need real positive change in the real economy – more jobs, higher wages, higher net worth. QE doesn’t provide that. You can alter public perception briefly by screaming in the streets, but ultimately, without some real world impact people just begin to ignore you. And this might just be the greatest problem with QE. Not only will it do little to nothing to solve the economic malaise, but it threatens the credibility of the Federal Reserve who has now gone “all in” on a policy tool that I believe Mr. Bernanke himself does not even fully understand. If it doesn’t work the Fed will be viewed as the emperor with no clothes and that will be one more notch on devil’s tool of discouragement. And ultimately, that will have the exact OPPOSITE effect that Mr. Krugman and Mr. Bernanke are hoping for.