Home > Uncategorized > Keynes was right about Quantitative Easing (QE)

Keynes was right about Quantitative Easing (QE)


Did the growth of money caused by QE in the Eurozone (graph) stimulate economic activity? Not enough. According to John Maynard Keynes, in The general theory(1936),

The relation of changes in M (money) to Y (income) and r (the interest rate) depends, in the first instance, on the way in which changes in M come about.”

Put differently: credit and not money makes the world go round. Money creating lending to enable household purchases of existing homes has a quite different effect on the economy than money creating lending to exiting new companies which hire lots of labor to produce live saving medical equipment (or the latest craze, L.O.L. balls, works too). Quantitative easing by central banks is a nice albeit dismal empirical example which shows that the amount of money did grow thanks to QE – but that the wrong sectors obtained the money. QE consists of a central bank buying bonds from for instance banks, pension funds and insurance companies. The graph shows that contributed quite a bit to money growth as we measure it. The money obtained by banks selling bonds (the light green bars) is not assumed to be part of ‘social money’ (i.e. money going around in the economy or M-3 money). The QE money paid to pension funds and insurance companies and the like (the light blue bars minus the light green bars) is however assumed to be part of M-3. But pension funds do not spend it in a useful way. They only buy other bonds and financial assets with the money. It would have been nice when pension funds, in a concerted effort with governments, had used QE money to invest in new houses, for instance in Amsterdam or London. But they generally don’t. Keynes was right – just looking at M is not enough. And  QE was wrong – at least the kind of QE we’ve seen until today. QE as we know it can be defined as the unique way to expand the amount of money in a way that influences Y the least. Even buying bad debts from banks (and writing them down) would have been a better idea.

About the graph:

The thin blue line indicates the growth of M-3 money. The light blue bars stand for the amount of QE money going to pension funds and insurance companies and the like, to pay for existing bonds. The light green bars are bonds sold by banks (money flowing into banks is not considered to be part of M-3). The net contribution of the ‘MFI’ sector (monetary financial institutions, i.e. banks plus the ECB)  to Eurozone moneygrowth is the light blue bars minus the light green bars and the purple bars. Interestingly, the net contribution of the ECB was, until the onset of QE, negative! ‘Net external assets’ can be understood as money flowing to Switzerland and comparable countries.

  1. November 14, 2017 at 3:00 am

    “Quantitative easing by central banks is a nice albeit dismal empirical example which shows that the amount of money did grow thanks to QE – but that the wrong sectors obtained the money.”

    As you point out, the ECB decided to increase the money supply within one particular sector of the economy, the only one it really cares about: the assets markets of particular interest to the most wealthy members of society.

    I think it is very significant that the ECB—renowned for its opposition to inflation when it occurs within a particular sector of the economy—has no fundamental objection to price inflation when it occurs within the assets (+ luxuries) markets. That, of course, is why asset “bubbles” are actually encouraged/celebrated by the financial services sector of the economy.

    Economists need to start asking themselves: if inflation is the menacing evil it is made out to be, then why do central banks not fight inflation when it occurs within the upper class as vigorously as it does inflation occurring within the lower classes?

    I think we know the answer to that: inflated incomes within the lower classes represents a cost to those who usually pay their salaries, the richest members of society.

    Contrary to what most economists believe, price inflation is not some kind of mysterious effect which spreads out evenly like a mist over the entire economy, causing all prices to increase by about the same percentage.

    Inflation rates can and do vary across different income groups:

    Incredibly, most economists do not recognize this fact. I suspect most of the blame for this can probably be attributed to Irving Fisher, who succeeded in popularizing his conceptualization of “The Price Level” within theoretical circles, a construct which essentially assumes that when price inflation occurs, it affects all members of society in roughly the same way.

    Nothing could be further from the truth.

    • Merijn Knibbe
      November 15, 2017 at 7:45 am

      Totally agree with your idea about inflation: it’s not the purchasing power of money (Irving Fisher) but the purhcasing power of income – and levels of income and patterns of spending do differ between demographic or income groups. I once wrote a post about this on this blog:

      ‘Did horse vets really become that expensive’

      which however criticizes the idea that the rich are worse of thanks to different kinds of spending https://www.google.nl/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&cad=rja&uact=8&ved=0ahUKEwj-ncf2icDXAhXDbBoKHfURCnwQFggqMAA&url=https%3A%2F%2Frwer.wordpress.com%2F2010%2F10%2F11%2Fdid-horse-vets-really-become-that-expensive-robert-j-gordon-on-inequality%2F&usg=AOvVaw1MeryL235vqSzfIj2SlvjQ

      It is totally kosher to, as you do, look at total spending of different groups to calculate income group inflation rates. One might however also want to look at the influence of price increases of necessities on real income of the top 10%

      • November 16, 2017 at 3:13 am

        Re: the “expensive horse vets”, I’d say your criticism of Gordon’s assumptions + reasoning re: his estimates of changes in purchasing power was spot on.

        I believe these kinds of misconceived analytical constructs would be obviated if economist statisticians could be persuaded to replace these ridiculous “averaging” estimates of inflation “for everybody” with a full spectrum of calculated inflation rates that are actually experienced by different income groups.

        It would change our discussions of inflation and purchasing power and monetary policy in a profound way.

        And it would all be in the name of increasing the accuracy of economists’ attempts to calculate the impact of policy proposals on the purchasing power of various participants in the economy.

        What are the chances?

  2. November 14, 2017 at 6:48 pm

    It seems to me that QE is a way to make sure that ordinary salaries do not inflate (increase) while the amount of money flowing to those who deal in the stock market is ever increasing. Most of the QE money could be considered “hoarding.”

  3. Risk Analyst
    November 15, 2017 at 12:32 am

    Things like good French pastries and castles and M3 may exist in Europe, but they don’t exist in the US. As I recall, the Federal Reserve stopped calculating M3 back in 2006 saying that measure does not have enough explanatory power to be worth the effort of calculation. That is remarkable since it was likely done by some guy with a green visor in the basement of the Fed. This would be a rather low bar for effort.

    In Janet Yellen’s last semi-annual Congressional testimony on Monetary Policy, she did not once mention M3, or M2, or M1, or “money supply” or even use the word “money.” She did mention monetary policy as something to do with interest rates. I think the Fed has recognized the endogeneity of money and per the last couple of comments, perhaps M3 is more a measure of political influence or as an attempt to goose up asset prices. Perhaps that is why the guy with the green visor no longer is at his desk.

    • Merijn Knibbe
      November 15, 2017 at 7:37 am

      That’s the whole problem. Friedman and Schwartz tought us (while Friedman was well aware of the existence of the Flow of Funds originated by Copeland and while Minsky criticized their views during special meetings) to look at money and only at money and not at sectoral data on credit or debt. But only looking at money indeed is not very interesting, as economists discovered. But instead of looking at a broader set of aggregates including flows of credit and stocks of debt they stopped looking at monetary aggregates entirely. The ECB fortunately still does present M3 data in a credit/sectoral framework. Kudo’s for the ECB! Remarkably, however, the Trichet regime at the ECB ignored al monetary warning signs (money, credit, debt, whatever).

  4. Thomas Michl
    January 4, 2018 at 2:23 pm

    Keynes actually advocated QE as a solution to a liquidity trap which he described as “deal[ing] boldly in debts of long term” in Ch. 15. The quantity of money is immaterial; what matters is whether QE affects the term structure–which the evidence suggests it did.

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