David R. Henderson  

Monetary Policy: Giving and Buying

The Sumnerian Missionary... What I Learned From the Crisis...

In discussions of monetary policy, I've noticed that some discussants fail to note the distinction between giving and buying. A young colleague asked me recently:

If you're trying to use monetary policy to increase aggregate demand, isn't it better to give the same amount of money to each person rather than to give it to wealthy people by buying bonds?

Similarly, in the comments on Bryan's recent post, Steven Roth writes:
Their reasoning? If we're printing money, it's better to give it to the elite few who have the knowledge and wisdom to allocate it in everyone's best interests (yeah: right), rather than distributing it widely and letting the wisdom of the crowds do its magic.

In both cases, my economist colleague and Steven Roth have made the same error: confusing giving and buying. In the case where the money is distributed widely, say, with a check per household, the government is literally giving people money. But if the Federal Reserve decides to buy bonds, it's not giving people money. Of course, the sellers of the bonds are better off; we know that because they sold. But the Fed didn't give them money. It bought bonds from them. And their gain is probably pennies on the dollar. In other words, if the Fed had offered to pay them, say, 97 cents per market value of the bond, they would likely sell close to zero of the bonds. In the case where the government distributes money to the household, the gain to a household from a dollar of money distributed is approximately one dollar. That's a pretty big difference. It's the difference between giving and buying.

Update: In the comment section of his blog post, Scott Sumner makes the point that I make above. See comment at 16. November 2010 at 17:59.

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CATEGORIES: Monetary Policy

COMMENTS (13 to date)
Lee Kelly writes:

The Fed is basically a highfalutin bank. Although the Fed's notes are not redeemable, they should be treated as such -- A virtual gold standard. Therefore, when the demand for the Fed's "liabilities" (i.e. base money) increases, savings are being lent to the Fed for investment. Unless the Fed purchases financial assets, savings will exceed investment, resources will be idled, and deflation will follow.

The Fed isn't just "printing money" and "giving" it to wealthy "elites." Instead, the Fed is equilibrating the supply and demand for credit by investing the resources loaned by its "liability" holders. (Well, at least, this is what the Fed should be doing when not busy deexisting to make way for free banking.)

thedirtymac writes:

In buying bonds, the Fed is also increasing the values of the bomds. The difference between the value with QE and the value without QE is in fact being given to someone. How is it different from "buying" $100 in currency from John Q. Public in exchange for $102 or some other arbitrary total?

Steve Roth writes:

David, you are absolutely right. Or would be, if I was suggesting that $600 billion should be helicoptered. I wasn't clear.

Another way of saying it: the government (in which I will include the Fed) is paying bondholders for the privilege of not paying them interest in the future. Like a householder paying down the mortgage.

As I've explained it to people: the government's basically issuing debt on one end and retiring it on the other. (Though it is generally presumed that it will come out of retirement eventually.)

In any case, assuming your numbers: that QE2 will push up bond prices by circa 3%, it's essentially delivering $18 billion to bondholders. (Plus any bump in the stock market as a result of declining bond yields.) Personally, I'd prefer to see that $18 billion injected via an increase in the Earned Income Tax Credit.

p.s. It's Steve or Stephen, but thanks for the effort at a respectful honorific.

Silas Barta writes:

So what if I characterize the transfer payment option as "buying the service of verifying numerous consumers' bank account values"? Did I eliminate the distinction you claim exists?

David R. Henderson writes:

@Silas Barta,

fundamentalist writes:

Dr Henderson is right about the distinction between buying and giving, but step back and look at the goal of the Fed: it wants to increase spending. It hopes that by buying bonds, people won't reinvest that cash in other bonds, but will spend it on say a new car. But that is not likely to happen. Bond sellers are more likely to put the cash into an Irish bond that pays 8% right now. So if you want people to spend, you need to give the money to people who will spend it.

Silas Barta writes:

@David_R._Henderson: I'm disputing that the helicopter drop can't be classified as "buying" something. It's basically the same point as saying that people on unemployment benefit are "employed" opening their mailings from the government, or that people in make-work projects are having their labor bought.

David R. Henderson writes:

@Silas Barta,
OK, now I get it. I think you're stretching. In make-work projects, people actually do something in return for the money. What they do might be useless or even destructive but it's a quid pro quo. Helicopter drops are not that.

Yancey Ward writes:

From Fundamentalist:

It hopes that by buying bonds, people won't reinvest that cash in other bonds, but will spend it on say a new car. But that is not likely to happen. Bond sellers are more likely to put the cash into an Irish bond that pays 8% right now. So if you want people to spend, you need to give the money to people who will spend it.

But what about the people who sell the Irish bonds to the people who sold their Treasuries to the Fed? What do they do with the cash? At the end of the line of transactions, who are the people who have cash, what do they spend it on, and how much of the $600 billion dollars the Fed started with is left at that point?

Troy Camplin writes:

Is it really buying if you get to create the money ex nihilo you buy with? Might as well give it away.

fundamentalist writes:

Yancy, the dollars could end up in the Irish central bank as reserves, or the Chinese central bank, in which case they come back to the US to buy more US bonds. Or it could end up in a US bank as more reserves that banks can't lend because no one is borrowing. It's impossible for the Fed to control where new money it creates goes and it rarely goes where the Feds want it to go.

Two Things writes:

But the Fed is "giving money" to favored people. It's deliberately using newly-printed (newly-instantiated?) fiat money to outbid the market for certain bonds-- giving the bondholders an increment they couldn't get from any productive-economy purchaser. Worse, when we view the whole mess from a distance, we see that the Fed is actually "giving" fiat money to the rest of the government (in "exchange" for dubious bonds the productive economy doesn't particularly want) so that officials and their cronies can spend it in competition with productive-economy participants.

"Quantitative easing" is just a large devaluation, by which the Fed and the rest of government confiscate wealth from the productive economy (including savers) and disburse it to their favorites.

Prakash writes:

Interfluidity pointed out that the Fed could helicopter drop via adjusting the accounts showing "Goodwill" as an asset to counter the printed notes which are a liability, as in we bought the goodwill of the American public.

I don't see the downside of his proposal. The money reaches everyone. The government promise to pay is atleast as bad an asset as "Goodwill". If the government fails, neither are worth anything. If the government continues, both are nominally worth a lot.

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