A Conservatiive Case For the Fed's QEII

David Beckworth National Review December 2, 2010

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David Beckworth

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December 1, 2010 4:00 A.M.

The Federal Reserve is back at it. After increasing the monetary base â?? currency in circulation and bank reserves â?? by about $1.2 trillion over the last two years, the Fed has decided to expand it again, by another $600 billion. This second round of â??quantitative easingâ? or QE2 has many conservatives worried. They are concerned that these staggering increases in the monetary base have the potential to unleash a 1970s-type inflation and put the country on the path to economic ruin.

Because of this unease, QE2 has been widely criticized by conservative commentators â?? including Sarah Palin, Rush Limbaugh, and Glenn Beck â?? and has led Republican representative Mike Pence (Ind.) and Republican senator Bob Corker (Tenn.) to introduce legislation that would change the mandate of the Federal Reserve.

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But in fact, if it works according to plan, QE2 will promote conservative principles.

One reason for this confusion is a failure by some conservative commentators to understand the real purpose of QE2. It is not solely about lowering interest rates, increasing bank reserves, and encouraging bank lending, though all of those will occur. Rather, it is about fixing a spike in the demand for money that has significantly hampered spending.

To better understand this excess-money-demand problem, consider the figure below, which is based on data from the Federal Reserve and the Survey of Professional Forecasters. It shows total current-dollar spending in the U.S. economy, as measured by nominal GDP, for the period 1993:Q1 through 2010:Q3; the consensus forecast for the series up through 2011:Q4; and the 1993â??2007 trend. Note the 2008 drop in total current-dollar spending relative to its former trend. The gap between the trend and reality is projected to get larger through 2011. In fact, by 2011:Q4, total current-dollar spending will be about $2.14 trillion below its trend.

Why the drop in 2008, followed by a sustained slump? The easy answer is that the housing bubble popped and caused a financial crisis. The resulting uncertainty from this crisis curtailed aggregate spending, which continues to stay depressed because of the ongoing deleveraging cycle.

While there is some truth to this view, it is incomplete and ignores some basic issues. First, total current-dollar spending is the product of the money supply and how often it is spent. Because the monetary base has been increasing so rapidly and there has been very little inflation, it must be the case that demand for the money must be increasing even more. In fact, money demand has been so pronounced that even the previous $1.2 trillion increase in the monetary base was not enough to prevent outright deflation in 2009 or a sustained decline in core inflation (which shows the trend path of inflation) over the past two years. Thus, a significant portion of the money supply is being hoarded and not spent. This is the excess-money-demand problem.

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Brad ONeal

12/01/10 10:16

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Mr. Beckworth, the real conservative solution to our current fiscal/political problem is sound money reform. Advocating for the Fed to further destroy the dollar so that the big banks can reap more profit even as they've made a moonscape of our economy is fool-hardy. Central banks around the world are the tap roots of big government socialism. Ending the US central bank would cut off the tap root and whither big government socialism. I don't see that solution offered much except on the gold bugs sites. I am a staunch social and fiscal conservative and to me it sounds like you're shilling for the big banks. I don't want to think that way, but apologizing for the Fed to take a bigger share of our incomes through currency inflation so that the Federal government can get stronger?!? Which side are you on?

I wish Ron Paul was a social conservative so that his sound money message would get through, but as a Libertarian candidate everyone puts a tin-foil hat on him and snickers below their breath. He is right! As was Thomas Jefferson regarding the role of central banks in growth and power of government.

Throw the spotlight on the corruption that comes from the incestuous relationship the big banks have through the Fed and how they bank-roll Congressmen - (mostly) Democrats and (but) Republicans (alike) to redistribute our wealth to the bankers and I'll give you some credibility, but until then you're on my "squishy" list.

Allesnarf

12/01/10 10:11

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This is a very dispiriting article to find on NRO.

First, there's the pathetic appeal to "conservatism": we have to indulge in foolish, interventionist economic policy because otherwise the public will demand even more foolish, more interventionist economic policy. This is the same argument that Fabian socialists always use. We have to have a welfare state to forstall a proletarian revolution; we have to pass a Medicare drug benefit to avert full-blown socialized medicine. Nonsense. Nothing in the current public mood suggests that people are clamoring for stimulus and intervention. Quite the contrary: "stimulus" is now a dirty word.

Even worse, though, is Mr. Beckworth's substantive argument. It's basically the same stale, Keynesian, magical thinking that we hear from the Left: People are irrationally "hoarding" their money, so we need to manipulate them into doing the rational thing by threatening them with inflation. We can somehow magically create value if we churn money around and pay each other for ephemeral goods we don't need. We can simultaneously de-lever and increase spending.

This is positively pernicious. Money will emerge, and be invested, when to do so is rational. Wealth is not created by consumer spending. NRO should be doing everything it can to drill home these points and break the hold that Keynesian arguments have on the public mind, not running apologists like Mr. Beckwith.

John Chivington

12/01/10 09:53

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Mr. Beckworth presents no credible justification for printing more money. What in the world is "money demand?" Money is a means of exchange, not a good or service that is produced and sold. I feel sorry for the poor students of professor Beckworth who are being required to study ideas that make no sense.

JPK

12/01/10 09:42

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Mr. Beckworth hasn't convinced me. Inflation is already here -has been since early 2009. By definition, anytime you increase the supply of money you introduce inflation. Price inflation, will surely follow. Besides, the CPI does not take into account the price of food or energy (both are commodities). The CPI tilts towards housing costs; we are still in an era of falling real estate prices. And most banks have substanital holdings in mortgages. With falling home prices, as well as the foreclosure mess, banks have a big cash flow problem. Add also the higher FDIC premiums banks must pay, and it is no wonder banks are "hoarding" thier dollars. And as thier mortgage assets depreciate banks must make up for the loses somewhere.

This is the quandry Bernecke finds himself. He must devalue the dollar in order to pry the "hoarded" cash from the fingers of reluctant banks and corporatons. Individual savers will be reluctant to invest in CDs or higher yeild money market accounts if dollar significantly depreciates. Bernecke hopes to artificially create demand at a time when consumers are very reluctant (and unable) to go on another consumption bender.

But, behind the scenes real estate and home prices continue to fall. This is the real problem that TARP failed to solve. Who knows where the bottom lies. The federal government surely doesn't know.

One last unintended consequence to all of this stimulus is speculation. Negative interest rates and a falling dollar may not lead to higher corporate and consumer spending. But it could lead to a new market bubble.

shuntsu

12/01/10 09:03

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Please demonstrate to me what part of government control of free markets in any way demonstrates 'conservative principles.' Also please demonstrate to me why allowing the Fed to continue to play with money supply issues that directly contributed to the mess we're in now makes any sense. I have officially lost interest in NRO's opinion, thanks so much.

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Brad ONeal

12/01/10 10:16

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Allesnarf

12/01/10 10:11

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This is a very dispiriting article to find on NRO.

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A Conservatiive Case For the Fed's QEII

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