The Asymmetry of Ineffective and Worthless QE
(Jim Lo Scalzo/Pool via AP)
The Asymmetry of Ineffective and Worthless QE
(Jim Lo Scalzo/Pool via AP)
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Compared to the utterly turbulent world of today, 1990 wouldn’t really rate all that high on any reasonable scale of years to remember. Saddam Hussein’s Iraq would invade Kuwait kicking off the Gulf War, sure, but thirty-one years later the costs of its legacy absolutely drown the original episode rendering it an almost forgotten footnote; a quaint association, at most.

There was also a recession which began almost concurrently with the foreign military operation. No more than correlation in time, the contraction was an especially mild as well as brief one following what had been nearly a decade of unqualified and unbroken prosperity. In the landscape of historical business cycles, the 1990-91 recession sits at the bottom of any list of those to remember.

Given this, there doesn’t seem to be any good explanation for why 1990 serves as an absolutely crystal-clear demarcation between the last remnants of the Great Inflation and the middle meat of the so-called Great “Moderation” which followed. Something substantial had changed after the eighties were over, that much has been certain.

But what?

Naturally, suspicions might be drawn to the downturn itself. Economic theory posits that, Phillips Curve and all, rising slack means lower inflation. Short run, yes; long run, how?

It is a vexing riddle which has plagued Economic (Capital “E”) theory for these three decades since. The “science” behind inflation seemed to have been settled during its “greatness” eruption of the seventies. In that decade, Milton Friedman, Robert Lucas, and so many other mainstream luminaries had developed passable theories about how inflation must have worked – and how for too long it had been left to go so wrong.

Expectations theory came to dominate mainstream thought, only bolstered with the arrival of Paul Volcker at the Federal Reserve in place of the near-universally vilified (with good reason) Arthur Burns. For many Economists and especially those working at central banks, a mere mention of the name of Volcker is all that’s necessary to explain the Great Inflation’s modest end.

In other words, a dedicated inflation-fighting central bank can not only impact the short run, it can hold major sway over longer run expectations, too. By provoking not one but two consecutive deep recessions (the double-dip of 1980 then 1981-82), however he did it (no one really seems to know the exact details, just the correlation timing downturns to outward associations of Volcker’s monetary policy), this allegedly established the immutable supremacy of skilled technocratic management.

Don’t Fight The Fed!

What followed the rest of the eighties, however, wasn’t exactly un-inflationary; on the contrary, at several points during the decade it appeared as if the inflation phenomenon was set to return. Perhaps most famous (and the lowest hanging fruit), Paul Krugman, working for President Reagan’s (yep, Reagan) Council of Economic Advisors, he co-authored a memo with Larry Summers (that guy) called the Inflation Time Bomb advising Martin Feldstein of serious caution.

Its key part:

“We believe that it is reasonable to expect a significant reacceleration of inflation in the near future. Much of the apparent progress against inflation has resulted from the temporary side effects of tight money…."

Reagan’s economic plan, the pair argued, “will add five percentage points to future increases in consumer prices.”

Instead, the Great Inflation failed to return, but that didn’t mean inflation was absent. On the contrary, it would average a nearly steady 4%, not great, either, until something changed in and after the events of 1990.

But if Krugman, Summers, and most of the rest of their orthodox clique of Economists were wrong about the eighties, they were doubly stumped by the nineties. Lower inflation still, a true moderation in global consumer prices with no obvious reason (or combination of reasons) why the turn of the calendar from eighty-nine to ninety could be so crucial.

Volcker, then Greenspan?

Many came to wonder and want how it was effective monetary policy aimed at controlling people’s expectations. In short, Volcker “establishing” an inflation-fighting central bank while demonstrating its purpose could credibly limit the reach of consumer prices (even though it didn’t happen straight away; again, there was some serious inflation in the eighties, a fact obscured by the immediate comparison with ungodly inflation during the preceding seventies).

Perhaps, then, Volcker had created the expectations template which appeared to work moderately well before it was then passed to Alan Greenspan, his immediate successor, to perfect. Conventional history even now assigns great skill and aplomb to Mr. Greenspan first during the Crash of ’87, then the S&L Crisis, finally crediting him the original “successful” demonstration of interest rate targeting for the mild and temporary 1990-91 recession itself.

Was 1990 the year when this new monetary policy doctrine shown the brightest, showed the world how it was done, and thereby rammed down the ceiling on consumer prices for decades to come?

What convention gets wrong – to this day - is the “tight money” presumed of Volcker’s age. Money got tight as a matter of mistakes not policy and then it went elsewhere (this is where I remind you of Robert Roosa’s ‘84 quote about “new networks of interbank relations” “beyond the control of the Federal Reserve.”)

As I wrote last week just scratching the surface (starting with M1), massive monetary evolution from the fifties forward never stopped even if the consumer price inflation would. Transitioning into toward a mature state in the eighties, monetary growth began to more seriously explore other untapped regions beyond simply the US border. Too much money tended to chase too few goods in the seventies, then too much money would chase non-American (and more financial) opportunities in the eighties.

The eurodollar system had spent the decade before pulling open and widening the doors of true globalization, which right around 1990 had unlocked an ocean of previously untouchable labor. Deng in China, Eastern Europe, they all welcomed the flood of eurodollars.

Yet, Greenspan was quickly anointed the “maestro” having stitched together his own snappy suit from Volcker’s coattails. The myth of the inflation-fighter Fed (and other central banks like it) has been omnipresent in mainstream discourse because of what’s always left out of its models – and what has been inserted, by necessity, in its place.

Economists, quite simply, cannot explain this economic history without this myth. There is no way to reconcile reality with their equilibrium models absent expectations being central to inflation conditions; and effective expectations monetary policy being the supposed engine of that benevolence.

While this may have sounded plausible during that Great “Moderation”, first it was only this way because of the assumption national economies operate as distinct islands; that there is no true global economy, merely a loose confederation of patchwork nationalities with little influence between or even one from another. If inflation is low in the US, it gets presumed something US must be responsible.

But then the Global Financial Crisis of 2007-09 “somehow” showed up, bringing with it global deflation and economic destruction unparalleled since the thirties. This despite the alleged performance capabilities of a technocratic apex central bank set deep into the public’s long run expectations.

Not only did this show the world very strong evidence there was a globally-connected system after all, it further and rather neatly exposed these prevailing myths about central banks as, well, myths. Expectations? Who cared! Money, please.

Ever since, QE after QE after QE to play up inflation expectations to suddenly no avail. Given enough time and mountains of contrary evidence, this constant failure has aroused if only modest mainstream suspicions that something has to be off with Economic theory, specifically inflation and expectations.

Last month, the Federal Reserve Board’s Jeremy Rudd caused a minor stir when his paper Why Do We Think That Inflation Expectations Matter for Inflation? (And Should We?) excoriated just what its title says.

I don’t want to simplify too much, but essentially Economists believe in this expectations stuff because they want their econometrics to seem to work, but they won’t unless they can at least muster some kind of answer for especially inflation history surrounding 1990. The DSGE’s need this other equation:

“What I believe such a response misses [that all models are inherently flawed] is that the presence of expected inflation in these models provides essentially the only justification for the widespread view that expectations actually do influence inflation.” [emphasis added]

Economists believe in it because they put this function in their models, not because there is any real-world proof. With it, their models (up to 2007) could fit the data (which is not how it’s supposed to work). As Mr. Rudd meticulously documents, empirical evidence for inflation expectations is seriously lacking – and it always has been!

And this goes straight to the heart of the main question, both inflation (specifically)/economy (broadly) as well as what it is central banks actually do. Is the Volcker Myth…truly a myth?

“Second, the fact that inflation’s stochastic trend manifests its last persistent level shift after the 1990–1991 recession also seems relevant, in that it suggests that ‘whatever happened’ to inflation might be more related to its actual level’s having been kept low rather than to any ‘credibility’ that the Fed gained as an inflation fighter following the Volcker disinflation.”

Put another way, what Rudd is saying is that the central bank, in particular (especially those like Bernanke who intentionally sought to tie monetary policy with the Great “Moderation”; see: Stock and Watson), invented expectations as a way to take credit for what happened thereby allowing it to further perpetuate both mainstream models as well as its stranglehold on total discourse.

“And this apotheosis has occurred with minimal direct evidence, next-to-no examination of alternatives that might do a similar job fitting the available facts, and zero introspection as to whether it makes sense to use the particular assumptions or derived implications of a theoretical model to inform our priors (particularly when the ancillary assumptions of the model are so incredible and when the few clear predictions it makes are so wildly at odds with the available empirical evidence).”

Yet, given all this, even after the multitudes of monetary failures only beginning in August 2007, only now does anyone stand up and declare Emperor Fed free from any clothing; if anything, the “money printing” meme is as alive today as it has ever been.

There are, admittedly, reasonable questions about any assumed symmetries; meaning that expectations theories might not be directly translatable to the other side from inflation-fighting. Even if monetary policy using this framework to take credit for low inflation is indeed bunk, it might not necessarily discredit the same on the flipside trying to makeinflation from none.

But it’s not off to a great start, is it?

And it only gets worse by examining the theoretical pieces, particularly how expectations theory tries to assemble (using the money illusion) a practical advice of real economy mechanics – how does labor, for example, actually translate these expectations into action? Rudd wonders:

“In situations where inflation is relatively low on average, it also seems likely that there will be less of a concern on workers’ part about changes in the cost of living—that is, a smaller proportion of quits will reflect workers’ attempts to offset higher consumer prices by finding a better-paying job. But this is a story about outcomes, not expectations.”

These questions are added to the growing volume of scholarship diminishing the previously uncritical view of QE and post-crisis inflation policies which depend exclusively on the same expectations manipulation agenda. Not only do Economists fail to produce any evidence for this, they don’t really know how it would work if it ever could!

Either monetary policy was perfectly spot on and effective from 1990 to 2007 for reasons lacking in evidence and explanation, not as much before that range nor at all after, or there must be another completely separate account which doesn’t require so many unbacked leaps as a matter of invented mathematical necessity.

Something that isn’t under the control of the Federal Reserve, something monetary in nature, and whose reach is worldwide.

No one’s been able to provide evidence for how history might have unfolded the way everyone wanted, but reinforcement in rigid ideology spread through Economics and an uncritical financial media left a couple generations to just “trust the Fed.” Jeremy Rudd’s summation of this missing support and verification is appropriate here: “And in some cases, the illusion of control is arguably more likely to cause problems than an actual lack of control.”

That is the asymmetry of ineffective and worthless QE.

Whatever you think of consumer price behavior in 2021, it has not been due to excessive money printing or any money whatsoever, yet it is totally understandable why an exceedingly large proportion of the public thinks this way anyway and more than a few have still acted (especially financially) on those thoughts.

It isn’t even what the Federal Reserve does, a fact of operation preceding Paul Volcker. They know it, have known it, and know better that you don’t. Expectation theory has never been anything more than a coverup, trying and failing to fill in these gigantic inflationary blanks left over from monetary evolutions which stretch even further back in time.


Jeffrey Snider is the Head of Global Research at Alhambra Partners. 

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