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Quantitative Easing Explained Or Cartoony Fallacies?

Posted on the 11 June 2011 by Realizingresonance @RealizResonance


There is a really problematic misunderstanding of the Federal Reserve’s role in the economy brewing in this country. All of the sudden everyone on the internet is an expert about central banking and monetary policy. I blame this on Ron Paul and his supporters (I used to be one of these so I would know), gold traders and their hyperbolic advertising, and this wildly fallacious xtranormal cartoon on Youtube called “Quantitative Easing Explained”. This cartoon has gone viral. The two rounds of Quantitative Easing, or QE1 and QE2, are the Federal Reserve’s policies of monetizing US debt in order to pump liquidity into the banking system, and stimulate the economy and job growth. This cartoon purports to explain it, but really just expresses several fallacies that completely distort what is really going on. I am determined to defeat this cartoon. Please watch it below if you have never seen it before and read my response:

Here are some of the problems that I find in this cartoon’s explanation:

“Printing money is the last refuge of failed economic empires and banana republics.” Wrong. Open Market Operations (OMO) have been used by the Federal Reserve System, and other central banks from around the world, to “print money” and add liquidity to financial systems since before I was born. The claim about failed empires is hyperbole meant to invoke the specter of hyperinflation, but QE1 and QE2 are hardly to this extent. Remember, the hyperinflation of the Weimar Republic in 1920s Germany was 1 million percent, not the roughly two percent that we have now. By the way, it’s called “Quantitative Easing” because it is the process of adding liquidity to the financial system after interest rates have already been pushed to 0%. When the Fed uses OMOs to move interest rates it signals the market by setting a rates target, so given that there is no new target to set at a rate of 0%, it reports that it will add a specific quantity of dollars in liquidity. For example, the quantity in QE2 was 600 billion dollars over the course of 6 months.

Inflation is always bad, and deflation is good. Wrong. Optimum inflation is about 2% according to most economists, and deflation is never good. It is a fallacy to think that deflation is the people’s wages staying constant or rising, while the prices of goods and services they desire fall. This is not what deflation is. To learn more about what deflation actually is and why it’s bad, read my article “The Case against Deflation”. Also, for my 2011 inflation prediction, read my article “Inflation and the Cost of Thanksgiving Dinner”.

The criticism that the core Consumer Price Index (CPI) statistic does not include food and energy prices is not economically based, but populist based. The headline CPI number reported in the press does include food and energy, but core CPI is better for monetary policy decisions because it will pick up food and energy inflation if sustained. Food and energy prices are highly volatile due to many complex factors and interest rate policy should not be made highly volatile as well, just to appease a populist or ideological sentiment. Food and energy inflation is problematic for families I agree, but using monetary policy to address what is typically a demand, supply, or speculation problem, is just attempting price controls with a very inefficient lever, even for this misguided purpose.

“The Fed has been wrong about everything.” This is a superlative that does not fit the reality of how most economists and finance professionals view the Fed and its history. Problems are caused by humans for human reasons, not because of the proper workings of the institution. The Fed has often been successful at fixing its own mistakes, but this depends on who the Chairman is, or at what time in the business cycle it is and nature of the decline or boom. Also, forward looking public statements are always going to be politically massaged from the Fed because they move markets. Especially when these are statements made at the peak of a boom. If the Fed Chairman calls a bubble, and suggests it is certain to pop, it will be certain to pop, and become a self-fulfilling prophecy, and then he will have been correct just by virtue of saying it. I don’t want this sort of accuracy, do you? Fed Chairmen and other economic stewards don’t like getting blamed for popping bubbles, and so they will always try to sound as upbeat about the future as they can. This does not mean that they are wrong about the policies that they implement.

The Bernanke is called out for not having business or policy experience, but The Dudley is called out for working at The Goldman Sachs? That is contradictory. The Bernanke never ran an election campaign? This is completely irrelevant. Attempting to ruin the credibility of a serious academic and concerned steward of our economy using such tactics makes me suspicious. I don’t think the author of this cartoon knows much about Bernanke and has not likely read his work. Ben Bernanke is the Great Depression - Monetary Policy Guru in the US. Not hard to see why both Bush, Obama, and the financial sector have relied on him. He was Time’s 2009 Person of the Year because he was recognized by most economists to have saved the financial system from the brink of complete collapse. I know Ron Paul likes to call him a counterfeiter, but this is a politically charged and inappropriate metaphor, like calling Social Security a ponzi scheme.

All in all, this cartoon does not explain anything useful about the Fed, and only gives the illusion that one understands something about economics and monetary policy. The creator of this cartoon, Omid Malekan, said in an interview, “I made a video that takes a subject that’s normally in the hands of Phd’s and really, really old guys in expensive suits, and brought it down the level of two talking bears.” Yes, yes you did. It is much more complicated and counterintuitive than what you might think. Innocent bystanders, I encourage you to seek out an unbiased understanding of what the monetary policy tool is really about and how it compares to alternatives. Especially if you have been led to believe that a return to the gold standard is a good idea.

Jared Roy Endicott

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By alex
posted on 30 June at 03:59
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and conspiracy theory, when everything i've said here is even admitted on and is non-disputed historical facts? Bah, you are a silly person, lets just leave it at that.

By alex
posted on 30 June at 03:56
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I do understand your words thank you, and they do not answer the core question. You are just trying to use a over-your-head debate technique, hoping that I will be impressed by your 'big' words (which I am not) and thinking you must be really smart because you have a job (wow, you're so special!) and are doing 'research' (holy cow, you read books and use google?!). I hate to break it to you, but you are not impressive at all. And neither are your blog entries. You should do something more productive with your time, like actually researching and understanding the financial system instead of just parroting what you read in crusty old literature written by establishment hacks.

By  Realizingresonance
posted on 30 June at 03:22
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I did answer your question, if you would only understand my words. I clearly don't see reality through the conspiracy lense that you do, and don't agree with your characterization of the Federal Reserve. But I did say i would give you the last word, so...

By alex
posted on 30 June at 02:22
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Wow, so many big words, and yet you fail to answer the question I posed, so I ask it again: why would you want to preserve a system where a private for-profit banking cartel can counterfeit money and lend it to the government at interest?

By  Realizingresonance
posted on 30 June at 00:30
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Thank you for your comment Alex. Chomping at the bit for my reply I see. I apologize for my delay, for I am a busy person, with a full time job, a family, research to conduct, new blog articles to write, and I am preparing for a trip to Canada for a conference. I may not always be able to meet the standards of proof and turnaround time that you are demanding, but I appreciate the challenges you pose. Also, I saw that you critiqued my Deflation article on my other site, so I will try to respond to that here as well. Unfortunately this will be the last response I can give on this for now. You have created an impossible test for me in regards to a consensus of economists, because I have no signed letter by all economists everywhere that proclaims their support for a 2% optimum inflation rate. But you already knew that. However, most professional economists do agree that a rate of inflation around 2% is best, and the survey I am citing can be sourced here: The explanations given for why a low and stable rate of inflation is good are as follows: 1) Rates below and above a rate of 2% tend to lead to volatility in the rate of inflation, which causes instability in the interest rate, which causes investment uncertainty, which causes hiring insecurity, which causes job insecurity, and ultimately results in a slowdown of production and employment generally.
2) A low inflation rate has the potential to cause a negative real interest rate, which stimulates economic growth. For example, this can happen if banks lend at 2%, and the real inflation rate is 3%, making the real interest rate -1%. 3) A low and stable inflation rate makes labor market adjustments smoother and easier, avoiding large long term labor market disruptions. 4) The demand for money in the market grows normally, and this causes disruptions if the supply and demand of money is mismatched. The gold standard, or hard currency scheme, does not prevent the problems of inflation and deflation. However, it does prevent policy makers from having a lever with which to stop deflation should it occur, and this has not worked out well in the past, especially after financial panics, which did occur under the gold standard too. Establishing authority on a subject through the demonstration of academic study and success is a perfectly fair card to play. In purely logical terms, appeals to authority are fallacious arguments, but in the realm of political economy, a domain that only allows for logic in limited sense through the application of the ceteris paribus clause to any claim of economic law, authority is how you get people to listen when everyone is talking at the same time, generally parroting each other, with a regress that leads you back some other authority. Logic rarely helps here. The moral philosopher Adam Smith suggested that specialization and division of labor is how capitalist economies thrive, and so in the realm of economic policy advice, which is rife with conceptual difficulty, it makes sense for there to be experts that we rely on and trust. The eminent 19th century economist, Leon Walras said, “Laissez-faire is an economics that can be taught to a parrot in the morning using morsels of sugar.” It’s too simple of a model to describe the whole of economic reality and it leads to incorrect conclusions when relied on exclusively. Laissez-faire logic is easy to grasp, but it turns out it is too easy to be of much practical use, and turns economic science into a faith based approach. Because pure logic is such a poor tool for understanding phenomenon as complex as economics, it can only be used in simple models in a limited sense. An economy is a dynamic, adaptive, interconnected set of individual actions that are governed by the deterministic chaos of feedback loops and macro-emergence. Logic just is not sufficient for prediction here. This is my critique of the Austrian School method, which I think is too simple, and relies too much on axiomatic truths and their logical extrapolations. I rely heavily on historical analogue and econometrically based models, and sound statistical studies, including surveys of economists, and cross country comparisons. I don’t rely on these methods because they are perfect logically and provide ultimate proof, an impossible standard, but because think that inference to the best explanation is closet we can get to objective truth in the wider contexts. I am not denying that conspiracies exist, and I am certainly not trying to bring back the dark ages, or just laugh at you. I am saying that the theory about the Federal Reserve, which you pointed me to, is a conspiracy theory. This makes it more difficult for me to It requires a significant re-reading of the historical assumptions about a significant number of events, and it does this not by offering us any new historical evidence, but by a re-interpretation using selective support for connect-the-dot circumstantial insinuations, backed by circular assumptions about conspiratorial intentions, and comparisons to a utopian counterfactual that proclaims we would be better today if only we had never regulated banking with the Federal Reserve Act in 1913. Next month I am writing about the theme of Philosophy of History. I will be posting a long article on the historical events surrounding the Panic of 1873. This is an example of where hard money advocates created a persistent slump through the process of deflation, due to a move to the gold standard for a bi-metallic standard, in what was dubbed by farmers then as the “Crime of 73”.

By alex
posted on 29 June at 22:35
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what, no reply yet? forfeit?

By alex
posted on 29 June at 07:08
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You have yet to produce a source, signed by 'all economists' that backs up your claim. Where is it? We could discuss inflation and deflation all night long but to what point? I am not saying more or less inflation would be good, that is not what I'm here to argue. You asked me to read your blogposts, which I am halfway done with now, and I am pointing out that so far, they are not exactly masterful dissertations, with clear and concise logic leading to conclusions but rather 'Bernanke and "all" economists say X, so X is true, yay!'.

As for my Federal Reserve "conspiracy theory", words I suppose you write in a condescending matter, there is no need to talk about theories. How about we discuss the facts instead, for I am sure you are aware of the basic operational procedure of the Federal Reserve. The Fed creates money out of thin air and uses it to purchase T-bills from the treasury. The taxpayers lose in two ways - we have to pay interest on even more debt to the Fed, and every dollar we own becomes worth less, which is another tax on us although most people do not understand this.

So my question is, what could possibly ever convince you that this system should be preserved?

Or did they teach you that this is a 'conspiracy theory' and that at no time in world history has any group of people ever conspired to do anything at all, so the argument is null and void and should only be laughed at when brought up? I do realize that this is a fairly popular belief system in this dark age, but I can't imagine you are actually on this boat, are you?

By  Realizingresonance
posted on 29 June at 05:17
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Thank you for your reponse Alex. If you believe that all economists can know about the economy is their opinions, then I suppose you must also think that what all physicists know about gravity is their opinion. You made an analogy that demonstrates nothing about my inflation claim, which is was determined by a survey conducted by the Teaching Company for the lecture series Modern Economic Issues, precisely the lecture of Inflation. If all I am expressing is my oponion and not facts, or sound theories, what can you claim about your Federal Reserve conspiracy theory?

By alex
posted on 29 June at 03:36
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This is not a factual debunking of the youtube clip you set out to debunk. It is just an exposé of your own opinions. Example:

"Inflation is always bad, and deflation is good. Wrong. Optimum inflation is about 2% according to most economists, and deflation is never good."

There are many problems with this statement. Where is the study that has asked all "economists" what they think about inflation? And even if most economists do believe one thing, it does not necessarily make it so. 98 out of 100 people thinking that the Eiffel tower is made out of yello does not mean that the Eiffel tower indeed IS made out of yello. You are claiming a fact based on other peoples alleged opinions, and THAT my friend is wrong.

By  Realizingresonance
posted on 12 June at 00:54
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My link for the "Case against Deflation" article is bad and goes to a different article. Here is the correct link: