Quantitative Easing

What isn’t easy is to remember what the Federal Reserve’s latest monetary whip, to energize a sluggish economy, means. Here I teach myself again.

Put in the simplest words, quantitative easing is another way of saying “printing more money.” And the name applied here is “quantitative” because the Fed determines in advance what quantity of money it will print. The “easing” part is trickier.

The Fed buys, from the banks, long term financial instruments that they are holding. An example is mortgage-backed securities. The Fed pays for this with money it creates out of thin air. The consequences? The banks have more cash. When instruments are purchased, their value goes up. When dividend-yielding financial instruments are purchased, their value goes up too—but their dividend yields go down. QE therefore reduces “yields” as well. Another name for yield is interest rate.

Now the “easing” part is tricky because what the Fed wants the banks to do is to lend the extra money to businesses and industry. Business and industry spend the money on structures and capital goods. This causes demand to increase. Demand in turn causes companies to produce. And in order to produce, they hire people. Simple, but very indirect.

The current situation is that banks don’t want to lend to people who need money; they want to lend to the wealthy only—who don’t need money. Banks behave like this because the risks of lending into a sluggish economy are high. But the banks love quantitative easing because they don’t mind selling long-term financial securities. It increases their flexibility without imposing a cost or forcing them  to do anything.

The very fact that the Fed must print money to begin this attempt to stimulate the economy, very indirectly, increases the money supply at a time when there is already too much money in circulation. This means that quantitative easing is inflationary. Inflation hurts people who save and those on fixed incomes; it helps people who borrow; they pay back loans with money that is worth less than the money they borrowed.

Now the straightforward way to stimulate the economy is denied to the Fed—but at least theoretically available to the Executive branch. That way is to launch programs to hire people directly—as Federal employees. If the programs are well designed, thus if the people hired actually believe that the job will still be around in a couple of years, they will start consuming. That causes demand to increase—and the “easing” then follows.

I feel for the Fed. It wants to do what the Executive branch might wish to do but hell will freeze over before the Legislative branch will let it do it.

Snapshot: The Federal Reserve System

The Federal Reserve System is now in the news, not least divergent views within the system. The New York Times, this morning, for instance, brings a profile of Thomas M. Hoenig, the soon-to-retire president of the Federal Reserve Bank of Kansas City. I’d read about Mr. Hoenig’s conservative and sensible views quite some time ago for the first time; they were unheeded outside and inside the Fed. He predicted the troubles we’re now seeing and has long been an advocate of severe management of risk. How? He advocates denying risk-taking banks government backing of their deposits. He also wants to reduce their access to emergency loans. Such is our celebrity culture, however, meaning so short our attention span, that only the Chairman of the Fed has any visibility in the media.

The Fed is rather an extensive and diverse sort of institution. Here a snapshot of its geographical extent, courtesy of this site maitained by the Federal Reserve Board:

The star emblem over Washington, DC shows the location of the seven-member Board of Governors. These are political appointees subject to Senate confirmation. The President appoints the Chair and Vice Chair from among sitting governors. They all have 14-year terms.

The Fed has 12 banks, marked on the map by black bullets. Five of the 12 bank presidents, alongside the seven members of the Board, form the Federal Open Market Committee (FOMC) where all the monetary policy is hammered out and decided by majority vote. One of the presidents, the president of the New York Fed, is a permanent member of the FOMC. That's the position Secretary Geithner held as his last job. The other four on that committee serve rotating one-year terms. Mr. Hoenig is not on the FOMC at present. Despite this limitation on voting, all presidents attend committee meetings and take part in the discussions.

Nine of the banks also have branches, marked by blue triangles on the map. The cities, shown by the district to which they belong, are these:

•   4 (Cleveland):  Cincinnati, Pittsburgh
•   5 (Richmond):  Baltimore, Charlotte
•   6 (Atlanta): Birmingham, Jacksonville, Miami, Nashville, New Orleans
•   7 (Chicago): Detroit (alas, we’re just a branch around here)
•   8 (St. Louis): Little Rock, Louisville, Memphis
•   9 (Minneapolis): Helena
• 10 (Kansas City): Denver, Oklahoma City, Omaha
• 11 (Dallas): El Paso, Houston, San Antonio
• 12 (San Francisco): Los Angeles, Portland, Salt Lake City, Seattle

I’m fond of the Fed, in a general sort of way. It points the way to rational governance in this high-tech, extremely complex age. The very fact that the Fed has problems getting its policies right—despite being well structured to do so—underlines our problems in other regions of governance where the structures are much more influenced by passions, ideology, and the new kind of bribery we call campaign contributions.

Years ago I did a job for the Minneapolis Fed. I invented, designed, and then programmed a game for the Apple computer. The game simulated the behavior of a central bank in the guise of a science fiction adventure called Return to Fraxla. Oh, the memories... The game was intended as an educational product to be distributed to schools—part of the Fed’s unfailing, and also always anxious efforts to reach out and to connect to a public that has MAJOR difficulties understanding this bastion of arcane mystery. One character in my Fraxla fiction was a little robot, QT. I had him playing the guitar, too, and right good music came out of the Apple II when you played the game...