Sunday 30 September 2012

Is QE deflationary?



Warren Mosler has claimed for some time that it is.


His argument is that QE deprives the private sector of interest income. And to buttress his argument here, he cites a Fed paper by Seth Carpenter.

But there is nothing in that paper about the interest income point. Well I couldn’t find it.

Strikes me the flaw in Warren’s argument is that it’s the TREASURY that funds the interest on government debt, and it does so out of taxation. Thus when debt is QEd, there is as Warren rightly points out a reduced level of income flowing to the private sector. But seems to me there is a corresponding reduced flow of money from the private sector to government in the form of the above reduced taxation. I.e. the net effect is nil.


Warren Mosler deserves a Nobel Prize for his contributions to economics, but I think he is wrong on the above point.


_________

P.S. (a few hours later). It seems from this freedom of information exchange of letters, that the Bank of England remits just HALF its profits to the Treasury. That means that when Gilts are QEd, about half the interest disappears into a black hole in the BoE. So the effect of QE is to withdraw monetary base from the private sector.

If that effect outweighs the stimulatory effects of QE, then QE in the U.K. will indeed be deflationary. In contrast, in the U.S., it looks like ALL PROFITS made by the Fed are remitted to the U.S.Treasury.



 

3 comments:

  1. It's a nominal vs real issue.

    The apparent reduction in taxation is due to the nominal short circuit via the central bank. Assuming government spending doesn't go up, then the post-QE equation is:

    G(o) + G(c) - T(o) - G(c).

    Where G(c) is the amount of government spending on interest on central bank held bonds *and* where the central bank sweeps the interest back to the Treasury.


    But since that hasn't now cycled via the private sector and its taxation function, a number of real transactions have not taken place that would have otherwise.

    The payment to the central bank is a single nominal transaction with an effective 100% tax rate. Nothing real happens.

    That is the case in the US.

    In the UK it is different because the Interest isn't swept back to the Treasury.

    Here Treasury has to issue bonds to obtain the reserves to pay the Bank of England who then sits on the cash. This has the effect of draining the QE money. In effect the Treasury has to issue bonds to cover the savings desires of the private sector *and* the Bank of England.

    So there are still an number of real transactions that don't happen because of the short-circuit, but less than in the US case.

    ReplyDelete
  2. Hi Neil,

    “Here Treasury has to issue bonds to obtain the reserves to pay the Bank of England who then sits on the cash.” So you mean there’s some sort of rule that forces the Treasury to issue bonds to fund interest payments to the BoE? Do you have any evidence for that (just to save me Googling)?

    However, I’ve actually just done some relevant Googling and uncovered an absolute gem. It’s a freedom of information request . . see link under the "PS" above.


    According to this, the BoE hands only HALF of its annual profits back to the Treasury, and according to the relevant BoE official, “The Bank retains it as a reserve against potential future losses.” Hilarious. A central bank storing up its own money is meaningless. The BoE could credit itself with a trillion to the power of a trillion pounds Sterling anytime. That’s more pounds than there are electrons in the universe at a rough guess.

    But more importantly, the fact of retaining 50% of profits constitutes a drain on the private sector’s holding of monetary base: so THERE IS a Mosler type drain on demand there.

    According to this, the BoE hands only HALF of its annual profits back to the Treasury, and according to the relevant BoE official, “The Bank retains it as a reserve against potential future losses.” Hilarious. A central bank storing up its own money is meaningless. The BoE could credit itself with a trillion to the power of a trillion pounds Sterling anytime. That’s more pounds than there are electrons in the universe at a rough guess.

    But more importantly, the fact of retaining 50% of profits constitutes a drain on the private sector’s holding of monetary base: so THERE IS a Mosler type drain on demand there.

    ReplyDelete
  3. What matters are the (net) funds/financial assets that are removed from the economy

    How govt accounts for that is inconsequential thanks for the kind words!!!

    Warren Mosler
    Senior Economic Advisor to the
    USVI Senate President
    29th Legislature

    ReplyDelete

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