Arnold Kling  

What if the Fed Bought Euros?

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Scott Sumner writes,

The US can't really use the exchange rate as a policy tool, it is too controversial.

And so, we have to turn to less controversial tools, like pouring more wood on what the CBO says is a fiscal fire.

That is not what Sumner says, of course. He says that the Fed can just announce a target for nominal GDP, and the markets will obey.

I find that highly implausible for nominal GDP, but I do find it plausible for the exchange rate. If the Fed announced a policy of "20 percent weaker dollar or bust," and proceeded to buy euros, yen, and other currencies, by golly, I do not think that private speculators would try to get in the way. And if foreign governments tried to get in the way, that would probably lead to some sort of worldwide monetary expansion that I imagine would make Sumner happy.

One point to make here is that this represents another reason to reject the notion of a liquidity trap. If the Fed runs out of T-bills to buy, it can always buy foreign currencies.

However, I cannot leave this issue without referring to the two-regime theory of monetary policy, which would say that this sort of policy risks moving the U.S. into a regime where the inflation rate becomes high and variable. Instead of keeping cash in mattresses, people will try to conserve on cash, and this will raise the velocity of money, even as the Fed is expanding the money supply. There is a risk that we will overshoot the inflation target. If higher inflation solves a lot of our unemployment problem, then, fine, Scott Sumner is a hero. If not, then, well, he is something else.

But it is certainly amusing to see Sumner dismiss a policy option as "too controversial," as if it competes with all sorts of noncontroversial alternatives that are in play.

Why is it "too controversial?" Is it too simple? The status-preservation theory of the Fed is that it wants to maintain an air of mystery and complexity around monetary policy. Buying foreign currency fails to satisfy that.

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CATEGORIES: Monetary Policy

COMMENTS (18 to date)
Felix writes:

Do I understand what goes on if the fed buys non-dollars?

The fed prints some dollars and gives it to someone in exchange for, say, Euros. After a while, the price of Euros in dollars goes up because the fed has bought all the cheap Euros.

Ah, the opportunities for gamesmanship.

For instance, if the fed knows it's gonna be dialing up the printing press, it can either sell those new dollars to someone who the fed likes and knows will unload 'em quickly before the rest of the world catches on. Or, the fed can sell the dollars to someone the fed doesn't like, but who the fed knows will hold on to the dollars. Or the fed can simply wink-wink its plans to a favored buyer, telling them there's plenty more where they come from and it might be a good idea to get rid of 'em now. Right now. Such wink-winking might be appropriate if, say, the buyer can buy things the fed cannot. That's teamwork in action.

Not that any of this gaming would go on in the real world, mind you. In the real world, there are algebraic equations that describe what goes on.

Or am I hopelessly confused?

Ted writes:

It's mostly controversial for two reasons. Some see exchange rate manipulation as beggar thy neighbor, but I find that argument strange since they best thing for any of our "neighbors" is to have a strong economy to consume their goods. Another reason is that the Fed doesn't manipulate the exchange rate (it can move the nominal rate temporarily just by normal policy, but it doesn't state this as an explicit goal), it's controlled by the Treasury so would likely require a coordination between the two institutions and some believe even the slightest intrusion into central bank independence is Armageddon.

Anyway, exchange rate manipulation happens as a by-product of expansionary monetary policy. When you run expansionary policy, the currency should depreciate.

Also, in Svensson's plan it's not actually about manipulating the exchange rate per-say. It's about a scheme that uses the exchange rate as a commitment device to overcome some time inconsistency problem (which I think is probably overstated but whatever).

8 writes:

FRB buys gold for $5000 an ounce. Dollar devalued. Didn't beggar thy neighbor, a euro is still 1.30 USD, except now it takes 3846 EUR to buy one ounce of gold.

Incentive for smart money to dishoard and be first to spend money.

david writes:


Which changes the relative price of gold and exactly nothing else.

Silas Barta writes:

I keep asking this because no one addresses it: How do we know that "more consumer spending" is an efficient use of resources? How do we differentiate the current status quo from one in which market signals are telling us, "Hey, you're poorer, you don't have the luxury to buy all your services from someone else; you need to do some of it yourself now"?

Why, exactly, is forcing the entire economy to ignore clear market signals about general productivity supposed to be a good idea? Why, why, why?

MikeDC writes:

Could we not simply "solve a lot of our unemployment problem" by:

1. Repealing the minimum wage increases that raised the cost of employing your average worker just as the recession was getting under way (bonus points for noting that the states with the highest unemployment rates have even higher minimum wages - Nevada, Michigan, California, Rhode Island for example)

2. Repealing the recent (and continuing) extension(s) of unemployment benefits that removes most any incentive except the basic ethical one for unemployed folks to go out and actually find a job.

3. Repealing the health care act that's introduced a boatload of confusion, complication and cost into everyone's lives at a critically bad moment to do so. This probably goes for the financial "reform" legislation too.

My guess is the first two policies would get us to 6-7%, and the last might get us back to our prior 4-5% baseline in relatively short order.

Is there anything really controversial about this? These are all really basic, widely accepted employment economics.

But because we don't want to accept these basic realities of our legislative choices, we're all supposed to go out and think magically about monetary policy as a panacea?

Lauren writes:

Hi, Silas.

You say

I keep asking this because no one addresses it: How do we know that "more consumer spending" is an efficient use of resources?
It's possible people are not addressing your question because your vocabulary is very confusing and not consistent with economic usage.

When economists talk about efficient use of resources, they are separating the economic activities of production and consumption. Resources are used in production--not consumption. Resources--also called inputs--such as coal, oil, or the time or education involved with labor can be organized to produce output--goods and services. That organization of inputs can be efficient or inefficient. Inefficiency could be caused by the entrepreneur's lack of understanding of better production techniques, or by government rules or taxes that encourage practices that change the company's incentives on how to use those resources, or by public-goods-like circumstances that come up in certain goods such as utilities or where property rights are unclear and that are specific and innate to certain markets and which make one industry use more or fewer resources than they would if they had to pay all the costs or received all the rewards involved.

Consumer spending uses no resources. It's what people spend after the fact from the income they made as a result of having produced goods. Consumer spending cannot be efficient or inefficient in its use of "resources." So, in economic terms you make no sense when you talk about consumer spending being an efficient or inefficient use of resources.

Are you trying to say that the government's focus of using tax money, regulation, government borrowing, and Federal Reserve policy to foster additional consumer spending is not an effective use of taxpayer's money? There you may have a point, though the word "efficiency" is distracting. The question is not one of efficiency. It is whether or not taxpayers--that is, consumers--want to buy the same things the government is spending their taxpayer money on. Consumers pay their taxes out of money they'd otherwise spend on other goods.

There is a possible efficiency question involved with regard to the economy's future growth. If taxpayers--consumers--prefer to use their income to develop new business ideas rather than on current consumption goods, then government programs that encourage consumption of current goods at the expense of that investment in the future misallocates resources toward those consumption goods (such as food, or specifically-targeted assets such as home ownership or new windows) rather than toward other investment goods (such as new business ideas).

In other words, while I think you may have some kind of interesting question buried in there, you are so conflating economic terminology and ideas that it's hard to figure out what you are asking.

8 writes:


Which is why it would be the least distortive method. It injects money into the economy, but through an instrument that is not debt nor an important input for business.

It's also about incentives. The smart money is exiting paper assets and entering physical assets such as gold. Revaluing gold changes their inflation and deflation expectations by delivering/destroying them.

Finally, Europe would be in much better shape given the size of their gold holdings.

Silas Barta writes:

@Lauren: I agree that the part you quoted may be unclear; that's why I've explained in detail exactly what I meant whenever I've posed the question, as I did here, and as I did in greater detail the last time I asked the question.

I'll put it a different way for anyone who doesn't understand: Economists are looking for ways that they can get people to spend more. But why should people be spending more than they currently are? That question asks the same thing.

If people have traded their labor for money and do not wish to redeem the money for goods now, on what basis do economists believe that they should be redeeming the money for goods, when the consumers holding the money do not wish to? If it's "to ensure there's a market for their labor in the first place", then that's just pushing the question back a level: why should anyone be producing the goods that the labor was used for?

Standard Econ 101 would say, "Well gosh, it looks like it must have been a mistake to produce those goods. Guess you'll just have to liquidate below cost and go find something else to produce." Yet economist act as if these goods *must* be sold at current prices, and we need to arm-twist consumers until they "see the light".

There may be an answer to my question somewhere, but no one's giving it, nor acknowledging that such a problem even exists. And as I've stated and restated it, it has an answer. The blog authors know what is meant by a "recalculation" problem: what would have to happen to restore the economy to a productive use of resources? I'm simply asking, "How do you know that making consumers spend more is part of that?"

Brian Clendinen writes:

@Silas Barta

I complete agree with you. How is saying consumers should spend more money any different than saying the government should spend more money? Economic growth comes from population growth (or more correctly more people entering the work force or providing some productive output) or the average person being more productive, either through more hours worked or more output per hour worked. How does generically saying consumers should spend more money lead to an increase in productivity? More consumer spending is a result of increased productivity but saying it is the primary cause of more productivity (aka real GDP growth) I think is silly.

Lauren writes:

Hi, Felix.

You write:

Do I understand what goes on if the fed buys non-dollars?
The fed prints some dollars and gives it to someone in exchange for, say, Euros. After a while, the price of Euros in dollars goes up because the fed has bought all the cheap Euros.
You get the right answer, but for the wrong reasons. Those wrong reasons are leading you to focus on some things that may not happen.

The price of Euros goes up not because all the cheap Euros get bought up, but because the supply of dollars rises relative to the quantity of all other goods and services on which dollars are spent. It doesn't matter whether the Fed uses the extra dollars it prints to first buy Euros, Treasury Bills, mortgages, or rotten apples.

It's a subtle but critical distinction. Economists all agree that an increase in supply causes the relative price of the item to fall. But there is a lot of disagreement on the mechanism or timing--sometimes called the adjustment process--by which that comes to pass. You've described a possible adjustment process; but the reason the price of the Euro goes up is not because of details that may occur during that adjustment process, but because of the increased supply of dollars relative to everything else.

There are two issues in understanding here. First, it's a little confusing when the item whose supply is increasing is dollars themselves. Supply and demand still work the same. An increase in the supply of dollars results in a fall in the relative price of the dollar--a fall in the number of other things you need to give up to trade for a dollar. That means a rise in the relative price of everything else. That is, an increase in dollars supplied by the Fed means that the dollar-denominated price of everything else--lettuce, Toyotas, cleaning services, health care, Treasury Bills, Euros, etc.--rises.

Economists agree on that.

But your argument focuses on one possible adjustment process--the Fed starts buying Euros that are relatively cheap and then they run out, driving their price up--rather than the underlying, fundamental change in the supply of dollars. Instead of saying "the price of Euros in dollars goes up because the fed has bought all the cheap Euros," I recommend saying "the price of Euros in dollars goes up because the fed has increased the supply of dollars."

The mechanism you describe may happen as part of the process. It's certainly true that gamesmanship can happen. However, it's equally possible that citizens and businesses and other central banks worldwide anticipate or even overreact to concerns about the Fed's printing money and buying Euros or whatever. Instead of creeping upwards as the "cheap" Euro price does in your story, the price of the Euro could overshoot even in advance because people are worried that the Fed might try to buy Euros and travellers, importers/exporters, and ordinary folks with money market funds may be thinking about that possibility. Even now the price of Euros might be high rather than cheap. In that case, the Fed's printing dollars could be accompanied by the price of the Euro falling simultaneously merely because the Fed is finally embarking on a clear action rather than everyone speculating about it! In this different economic environment, who knows?

The point, though is that economists don't know much about the adjustment process. Supply and demand determine the final outcome; but about the interim, it's harder to say.

Lauren writes:

Hi, Silas.

That's fine and much clearer, but it belonged in the more appropriate thread. This thread is about monetary policy and specifically exchange rate policy. Consumer spending questions here are additionally confusing because they aren't topical.

Silas Barta writes:

@Lauren: Arnold Kling's post here, though disagreeing with Scott Sumner, accepts Sumner's premise that steady NGDP growth would be good (if the Fed could achieve it), and total consumer spending is regarded as the fundamental determinant of NGDP. That is why I believe questioning that premise is relevant. Apologies if I did not make the connection clear.

(FWIW, no one answered the question there either -- or anywhere.)

Arnold Kling writes:

It seems like you come close to equating nominal GDP with consumption. If so, then that would not be correct.

For example, if the Fed were to buy foreign currency and this depreciated the dollar, exports would go up, imports would go down, and consumption probably would go down as well. The increase in GDP would come from an improved trade balance, not from more consumption.

If your issue is the assumption that everything depends on demand (spending) as opposed to supply, then I agree that such an assumption is unwise. My fear is that a Sumner-type experiment would increase nominal GDP but not real (price-adjusted) GDP, because the economic problems are more complex than just a shortfall in spending.

endorendil writes:

"If the Fed runs out of T-bills to buy, it can always buy foreign currencies."

Ok, the Fed prints more dollars. It cannot just give them to people, it has to buy something with them. If it buys T-bills, it gives the money to the US government to spend. That's always a safe bet: all of what the US government gets is spent, and most is spent on things that American firms produce. Buying foreign currencies is like giving the money to foreign entities (both firms and governments) to spend (it's a bit more complex in real life, but the buying of foreign currencies should reduce the cost of borrowing in that currency, which amounts to giving money to foreign entities). It's a safe bet that they will not spend that money to buy American products, at least not to the degree that the US government would. So there is a real difference.

Doc Merlin writes:

Oh, its also illegal for the Fed to use exchange rate as a policy tool. Foreign exchange rates are under the purview of the Treasury Department as Ben Bernanke keeps reminding Ron Paul.

Felix writes:

Lauren, thank you very much for your reply.

It certainly explains a lot.

an increase in dollars supplied by the Fed means that the dollar-denominated price of everything else--lettuce, Toyotas, cleaning services, health care, Treasury Bills, Euros, etc.--rises.

Economists agree on that.

Ah. Then this is a promising area to look for conceptual mistakes!

Anyway, Arnold suggested the Fed buy Euros. I'm curious to know who would be helped by that and who would lose. That a Fed-buy-Euros action might be illegal, as Doc Merlin says, is probably something that could be got around without too much trouble.

Focusing on what it means to devalue the dollar, what if Mr. Euro said, "Nice try. You wanna devalue your dollar, well, we'll just print some Euros for you and, viola, we'll keep right down with you, my friend."?

Jeff writes:

I've never found "two-regime" models very convincing. Why not three regimes? After all,

... then shalt thou count to three, no more, no less. Three shall be the number thou shalt count, and the number of the counting shall be three. Four shalt thou not count, neither count thou two, excepting that thou then proceed to three. Five is right out.

Book of Armaments, Chapter 2, verses 16-20

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