I missed this nice piece in the WSJ by John Cochrane. It’s a very balanced perspective of QE. I particularly liked this section which will sound very familiar to regulars:
“This policy is new and controversial. However, many arguments against it are based on fallacies. People forget that when the Fed creates a dollar of reserves, it buys a dollar of Treasurys or government-guaranteed mortgage-backed securities. A bank gives the Fed a $1 Treasury, the Fed flips a switch and increases the bank’s reserve account by $1. From this simple fact, it follows that:
• Reserves that pay market interest are not inflationary. Period. Now that banks have trillions more reserves than they need to satisfy regulations or service their deposits, banks don’t care if they hold another dollar of interest-paying reserves or another dollar of Treasurys. They are perfect substitutes at the margin. Exchanging red M&Ms for green M&Ms does not help your diet. Commenters have seen the astonishing rise in reserves—from $50 billion in 2007 to $2.7 trillion today—and warned of hyperinflation to come. This is simply wrong as long as reserves pay market interest.
• Large reserves also aren’t deflationary. Reserves are not “soaking up money that could be lent.” The Fed is not “paying banks not to lend out the money” and therefore “starving the economy of investment.” Every dollar invested in reserves is a dollar that used to be invested in a Treasury bill. A large Fed balance sheet has no effect on funds available for investment.
• The Fed is not “subsidizing banks” by paying interest on reserves. The interest that the Fed will pay on reserves will come from the interest it receives on its Treasury securities. If the Fed sold its government securities to banks, those banks would be getting the same interest directly from the Treasury.”
I like that. Sounds like he’s adopted my “asset swap” view of QE. Swapping red M&Ms for green M&Ms doesn’t help your diet. That’s exactly how QE works. Swapping T-bonds for reserves doesn’t mean the private sector has more financial assets or spending power. And it certainly doesn’t mean that banks are willing to lend more. Cochrane seems to understand endogenous money and reserve accounting which is pretty unusual for most mainstream economists.
So, the narrative appears to be shifting more and more towards the sorts of things I’ve been saying for the last 5 years. Which means that we’ve basically wasted all this time focusing on potential transmission mechanisms for stimulus that were never going to happen. And that’s 5 years of sub-par growth because we put our faith excessively in a program that does a whole lot less than people originally thought.
Better late than never I guess.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.