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Pragmatic Capitalism

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QE and Inflation.

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Is it correct to assume that QE has caused no inflation because for every £/$ created, there has been an equivalent T-Bond/Gilt created too? Therefore any inflationary effect caused by the extra £/$ in circulation, is being offset by the deflationary effect of their being more T-Bond’s/Gilts in existence?

Much the same as if a loan for $1M, to build a factory, end’s up building a factory worth $1M, meaning no net inflationary/deflationary activity has occurred?

I am very sorry if this seems a tad daft, but the whole ‘QE no inflation’ thing, really is a head scratcher for me.

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Posted by Jamie Box King
Posted on 03/20/2017 9:15 AM
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Private answer

It depends. QE1, for instance, resulting in Central Banks buying assets that might have otherwise become insolvent or far less valuable than they were with the Fed buying them. This helped stabilize the economy and resulted in inflation being higher than it otherwie would have been. Outside of a crisis environment like this it’s hard to say how inflationary QE actually is. Without any coinciding deficit spending the policy is probably inflation neutral as it’s really just an asset swap where the private sector trades a short duration for a long duration asset. Since this reduces private sector net income it could even be a bit deflationary.

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Cullen Roche Posted by Cullen Roche
Answered on 03/20/2017 4:58 PM
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    I see, so in terms of a straight asset swap, there is no inflation as there is essentially equivalent value traded in the swap. That would lead me to believe that the reason there was some inflation, during QE 1, is because the Fed was buying depreciating assets and therefore receiving a reduction in value for their non-equivalent cash swap?

    How does QE reduce private sector net income, and would a reduction in private sector net income not be an inflationary effect? As the value in the private sector is essentially temporarily reduced, whilst the equivalent cash amount still circulates?

    I understand there are some behavioral effects associated with QE working in tandem with the money supply issues, but I have tried to focus on the money supply side at the moment just to make sure I understood the basics at least.

    Lastly and I know this may sound radical but for the purpose of theory, if this: asset for asset = inflation neutral, is correct. Would it not be possible for the Fed to print and swap for high value infrastructure projects (With the associated risks they may not be the right ones(inflation). Or maby even the associated risks that they are too good and therefor over compensate greatly in value, for the additional money in now supply (deflation)?

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    Posted by Jamie Box King
    Answered on 03/21/2017 12:50 AM
      Private answer

      Yes, I have argued that QE1 was inflationary in that it helped halt the deflation of falling asset values and the many problems entangled in that.

      All else equal, QE reduces private sector net income because it takes the higher income paying instrument out of the private sector and gives the income to the govt which usually goes to paying down the deficit. The money doesn’t just get recycled back into the economy.

      The Fed does not have the budgetary authority to buy infrastructure projects or finance them directly. According to Section 14.1 of the Federal Reserve Act the Fed can purchase:

      Gold
      US Government Treasury Debt
      Agency Debt
      Bankers Acceptances and bills of exchange.
      State and municipal debt (limited to terms of 6 months)
      Foreign debt (limited to a term of 6 months)
      Foreign currency overnight deposits.

      So the Fed is fairly limited in how realistically it can influence the financing operations of the US Treasury.

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      Cullen Roche Posted by Cullen Roche
      Answered on 03/21/2017 12:42 PM
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        Also, QE1 was illegal fiscal policy as it wasn’t authorized by the Federal Reserve Act. Congress later passed legislation making QE1 explicitly illegal. No accountability, as usual.

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        Posted by MachineGhost
        Answered on 03/28/2017 11:29 PM
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          The BOE is also limited by statute to much similar restraints, with a few small exceptions as I believe they also reserve high value corporate bonds.

          My question was purely academic and would perhaps be best re-framed in the context where the Fed/BOE was able to purchase/sell newly minted ‘infrastructure bonds’. Assuming the political and legal will being there, of course.

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          Posted by Jamie Box King
          Answered on 04/01/2017 12:51 PM
            Private answer

            I guess it could work but it would be inflationary to the extent there are no-bid contracts, overcharging, rent seeking, etc. all the usual things that would not happen in a competitive private sector which always maximizes the ratio of value provided vs cost. For that to work at the government level, you need laws stating/disallowing certain behavior and you need bureaucrats enforcing it — additional bureaucratic costs right there — things that just happens naturally without any effort with the profit motive.

            Take Trump’s Border Wall. He’s started the bidding process and about 1,500 companies have already submitted proposals: https://www.fbo.gov/index?s=opportunity&mode=form&id=b8e1b2a6876519ca0aedd748e1e491cf
            Does anyone really think the lone finalist that wins the exclusive contract is not gonna juice it as much as they possibly can?

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            Posted by MachineGhost
            Answered on 04/01/2017 2:52 PM
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