Arnold Kling  

I Believe in Quantitative Easing

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The Parrot Shows Signs of Life... Dreaming the Simonian Dream...

James Hamilton writes,


Will [purchases of mortgage securities and other assets by the Fed] succeed if we just do it on a sufficiently large scale? I'm not at all convinced that it would. Our standard finance models treat interest rate spreads as governed primarily by fundamentals such as default risk and only secondarily by the volume of buyers or sellers.

Oh, please. "Our standard finance models" have absolutely nothing to say about crazy de-leveraging. If those models worked, we wouldn't be where we are now.

If the Fed brings the parrot back to life, and mark-to-market accounting of mortgage-backed securities and other non-Treasury bonds starts making bank balance sheets look stronger rather than weaker, the de-leveraging process could be interrupted or even reversed.

There are worrisome excesses in the real economy--too many houses, too many shopping malls. But if the Fed has managed to pull the financial sector out of its de-leveraging death spiral, we can look forward to a finite recession, which would be a lot better than Great Depression II.


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COMMENTS (8 to date)
Methinks writes:

Arnold,

What does our standard financial model say about crazy de-leveraging after a period of crazy leverage? We've just come off the tightest credit spreads in history which amounted to crazy leverage. I fear that if the Fed manages to re-inflate the credit bubble, we're looking at a finite recession now followed by an even worse pop a few years down the road.

El Presidente writes:

Oh, please. "Our standard finance models" have absolutely nothing to say about crazy de-leveraging. If those models worked, we wouldn't be where we are now.

Give 'em hell, Arnold! =)

I agree with the sentiment that it's time, or long past time, to question assumptions.

Variables that were generally thought to be predictable have changed direction and become very volatile. Our models usually work with a similar mechanism. We hold variables or relationships constant that we think are reliably stable, then we watch the others move around in response to stimuli. If the model becomes imbalanced, it collapses, and the variables that were stable become volatile. We don't need to throw the old models out in frustration (very tempting), but we do need to critique our assumptions and ask which ones are failing, and why. We can't be too eager to dismiss alternative explanations if we intend to learn from this experience.

Niccolo writes:

Arnold,


I'm not an economic expert by any means - I'm a management student who thinks purely in terms of management - so could you explain why deleveraging is necessarily a bad thing? Or was your point that it's bad now? If so, why?


My thought was that deleveraging was merely paying off debts on your balance sheet immediately in order to get rid of risks of defaulting.

From a budgeting perspective, this seems important. If I'm running a company, I want to grow, but I also want to make sure I don't go belly-up. Why shouldn't I do this?

floccina writes:

There are worrisome excesses in the real economy--too many houses, too many shopping malls.

Tongue in cheek

Like many of our so called problems (bad schools, bad performance of the children of the poor, failure of enough people born poor to rise out of poverty) this is nothing that allowing a few tens of millions of Chinese immigrants into the country would not solve.

Tongue out of cheek

floccina writes:

I do not usually believe that history repeats itself but what we need:

Clinton plays Kennedy and Johnson (1st Keynesians - money growth creates a boom economy)

Bush plays Nixon (Tries and succeeds in keeping it going as long as possible)
Obama plays Carter (presides of inflation and unemployment that the Keynesians said could not coexist)

Everybody realizes that more money/inflation is not keeping employment high enough and a Paul Volker is allowed to end inflation.

This time it was all done with monitary policy rather than fiscal policy and the inflation was lower and perhaps the unemployment will be lower also.

Bruno writes:

"Oh, please. "Our standard finance models" have absolutely nothing to say about crazy de-leveraging. If those models worked, we wouldn't be where we are now."

That's not true Arnold. Those models do work significantly fine in normal times. In unusual times they are not good tools, but that doesnt mean its failure has led us to where we are now. To say that modelling is useless is like saying math is useless. Trying to measure reality is not a foolish thing and can help us. In times with uncertainty a guess is just as good as a model. But in normal times a model can help you make decisions. Dont begin with the keynesian whining about models. Even though you are not keynesian, sure sounds like one.

Mick writes:

If only you realized the irony... the first time the Fed did debase the currency to save the economy WAS the Great Depression.

Dear Dear Dear Me.

You got there first with the Kling Principal - http://don-thelibertariandemocrat.blogspot.com/ (e.g. Ebenezer Archer Kling) -

Good on you.

Eli Kling

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