It also underlines the true role of Government borrowing, which is as a safe haven for investors, rather than an indicator of profligacy.

For the record I didn’t pick the headline here: the focus is very much on austerity rather than QE in restricting the supply of bonds

I don’t really follow this argument – QE makes the quantity of government bonds in circulation falls but the quantity of cash (reserves on deposit) rise.

I can just about follow the argument that a lack of collateral in the system might raise financing costs, but isn’t cash on reserve equally good collateral as a government bond?

I know you probably weren’t responsible for the ridiculous headline, but really to make that claim you need to show that not only are there costs to QE (alleged higher financing costs for UK banks – lets see some numbers please) but that those costs are sufficient to offset the benefits (inflation expectations, asset price change etc.) and that this net cost is having a quantitatively important affect on UK growth. You don’t even attempt such an argument, let alone provide any supporting data.

And as for this supposed irony …

This is rather embarrassing for neoliberalism, as it does illustrate that economic actors don’t always act in the way it says they ought.

oh come on, since when did “neoliberals” believe that governments act like welfare maximising rational agents?

ah Jon, I see.

Slightly less edited piece here with a few more points in it: http://theredrock.wordpress.com/2012/07/05/the-weird-contradictions-of-a-wanna-be-neoliberal-state/

As far as actually explaining the causes of the stresses on liquidity Frances’s piece is a much better and more comprehensive explanation (http://coppolacomment.blogspot.co.uk/2012/06/money-machine.html) – the original intent of this piece was really pointing out a few ironies, but I think that was mainly lost in the subbing.

Luis, re: what neoliberals actually believe – perhaps, but it’s still quite interesting to note that if the pro-debt financed stimulus people were in charge, they would actually be using the state in a way closer to a welfare maximising rational agent. It’s the fact that the former are running the show that means it isn’t like that.

Of course, they think the state is different to other agents, but it likely wouldn’t be so far removed if they weren’t intent on using it in a different way.

I also don’t think it’s far fetched to extend the workings of the state of other institutions as a wider point. You get politics and ideology in any large organisation. Though I admit it is somewhat of a caricature.

… except, I don’t

if austerity was restricting the supply of bonds, it would be working that is to say significantly reducing government borrowing. But I thought the line around these parts was austerity was self-defeating so only has a small impact on cutting the deficit.

QE is surely having a much much large effect on the quantity of bonds in circulation.

also are we really sure that “we need governments to be running large deficits to issue new bonds otherwise shadow banks will run out of collateral!” is a terribly good idea? I have read something (can’t find it) about ideas concerning the creation of new kinds of “safe” assets, but I’m not sure having governments perpetually spend more than they tax is going to help, stability wise. What happens when people don’t want to lend to them any more and we get a public finance crisis?

Well, whatever the reason, there is an undersupply/overdemand of public bonds – otherwise we wouldn’t have record low interest rates. Austerity, (lowers supply) QE, (higher demand cause by CB) a risk-averse attitude in investment (higher demand from financial institutions), regulatory requirements (higher demand from financial institutions) are all contributing factors, it’s possible to argue over their exact mix.

On the specific question of austerity not reducing the deficit by very much: sure, this is true, but the automatic stabilisers that kick in when a firm starts saving aren’t particular strong (are there any?) so while the state might react to householders and consumers losing their jobs by automatically increasing spending, it’s probably not going to be increasing the deficit exactly in line with the private sector sitting on cash and via the proxy of the banking sector putting it into government bonds. So you can still get a mismatch there.

Luis: “I’m not sure having governments perpetually spend more than they tax is going to help”

Quite so. On joining the Euro at its launch in January 2000, Italy’s national debt to national GDP ratio was 123pc – source: FT Birth of the Euro (Penguin Books 1998) p.96. On the Maastricht eligibility criteria, only Luxembourg met all the criteria. As Delors put in in an interview last December:

Euro doomed from start, says Jacques Delors

The euro project was flawed from the start and the current generation of European leaders has failed to address its fundamental problems, Jacques Delors, the architect of the single currency, declares today.

Jacques Delors interview: Euro would still be strong if it had been built to my plan
http://www.telegraph.co.uk/finance/financialcrisis/8932647/Euro-doomed-from-start-says-Jacques-Delors.html

Jon,

I don’t understand talk of “over” demand and “under” supply – it implies we’d be better off with “the right” demand and “the right” supply. But low interest rates are a deliberate policy choice designed to help stimulate the economy, so we’d be worse off if demand fell supply rose and interest rates rose.

Well the Government wouldn’t always have to be running a deficit – it only has to be running one when there’s an undersupply of safe assets, which tends to be when firms are saving rather than investing, which is when you should be running a public deficit anyway.

Demand would drop off when investment resumes, so you don’t need to the same volume – you know this by watching the interest rate. Price signals!

By the way, please don’t see this as post rationalisation of what I’ve written – this wasn’t the point I was trying to make in the article, so I didn’t really try to argue it – though I realise it is probably more interesting to the Liberal Conspiracy audience, hence probably why the headline was changed. I think Sunny would have probably done better just running Frances’s original piece.

Not sure whhere to begin on this article – but let me say that it is essentially total nonsense.

QE does indeed rudece the supply of govt bonds, but it doesn’t reduce the money supply at at (rather it increases it) and cash is considered a safe asset…so it doesn’t affect a bank’s ability to lend one bit.

What does affect bank’s ability to lend is Basel III’s increase in capital reserve requirements, which limits the amount a bank can lend on a fractional reserve basis.

You also miss the obvious answer as to why people are not investing and why corporates are hoarding cash rather than investing….that percieved returns on investing are very low at the moment and risks are too high.

And please don’t start with the “government can invest” nonsense. The simple shopper really isn’t a great example of investment savvy. Especially when you have to take into account the negative effect of the extra debt servicing has on GDP, not least through higher taxes needed, which for some unknown (cough) reason many Keynesian types thoroughly ignore when doing their calculations (please do read Reinhardt and Rogoff’s paper explaining this very nicely).

Last time I checked, there currently isn’t a liquidity crisis at all – thanks to central banks lowering interest rates and flooding the market with short term loans there is plenty of liiquidity, possibly even fuelling an asset bubble in equities, bonds and commdities….there is a government debt crisis though.

The only thing embarrassing in this article is the OP’s complete lack of knowledge concerning QE, financial markets and the causes of the current crisis.

Jon,

I can see that when firms are saving, that means they might be looking for safe assets. But if we are worried about bank financing costs because of stress in the shadow banking system, why can’t firms just lend directly to banks? Anyway, this is OT.

I don’t know why LC – I presume it is Sunny – likes this “QE is bad” angle. I think it’s very unhelpful considering that what we really need to help the Euro crisis is for the ECB to step up and do some more QE, taking EU sovereign debt onto its balance sheet and – maybe – leaving it there.

@11, Tyler: QE increases the monetary base, but it hasn’t been successful in increasing the money supply. See charts 8, 9 and 10

http://www.businessinsider.com/richard-koo-the-world-in-balance-sheet-recession-2012-4?op=1

I mentioned regulation in the comments.

Extra debt serving would cost practically nothing to anybody with interest rates this low: in terms of taxes, the pasty tax VAT loophole could pay for a £30bn (2% of GDP) investment http://notthetreasuryview.blogspot.co.uk/2012/05/four-charts-and-why-history-will-judge.html

But if you read up you’ll see there’s been some editing and mis-titling going on, I don’t claim to have argued for the first paragraph.

@9: I wouldn’t say there was a “right” interest rate, but there is one where it no longer becomes profitable to invest.

There’s a tradeoff between the effect with mortgages getting low interest rates, and resulting stimulatory effect of that, against the stimulatory effect of investment.

But if the way low interest rates are supposed to stimulate demand is to increase credit creation, and credit creation is falling off (see graphs in link above) and people can’t get mortgages or business loans, there’s clearly a blockage in the system somewhere else when interest rates are zero and we’re pumping up the monetary base.

If the problem is lack of collateral for the shadow banking system (because it services the banking system) rather than a lack of money in the economy then interest rates aren’t the problem here, so interest rates need to go up a bit. There may not be a “right interest rate” for everything but there is surely an optimal interest rate for stimulating the economy.

The lack of collateral is also the monetary side of the ‘no demand’ (thus low return on investment) coin – both are linked in that they’re two effects of a lack of public spending.

Yeah I think QE is probably at worst neutral in its effect. Confidence is probably the main benefit of it.

For what I actually think of QE: http://theredrock.wordpress.com/2012/02/09/the-government-cant-have-its-cake-and-eat-it-with-quantitative-easing/

And the original version of this piece if you want to see what I was trying to do: http://theredrock.wordpress.com/2012/07/05/the-weird-contradictions-of-a-wanna-be-neoliberal-state/

Jon,

I’m not quite following you – “there is an interest rate at which point it becomes no longer profitable to invest” – invest in what? Obviously as interest rate falls, the return on “investing” in debt, like a bond, falls, but so what? As you say, demand for bonds is high, we don’t have to worry about returns on bonds being too low do we? If you meant “invest” in the real economy, then profits only increase as interest rates fall, holding expected revenues (i.e. how much money you expect your new restaurant or whatever to take) constant.

What trade off is there with mortgages? Low interest rates help ease the burden of mortgage repayment, low interest rates make investing more profitable for firms. That’s not a trade-off, that’s a reinforcing stimulus.

If you observe credit creation falling, that could be explained by any number of things – low demand for borrowing because depressed economic conditions mean people expect borrowing money to open a restaurant or whatever to fail. It could be because banks are trying to shrink their balances sheets to raise their capital buffers, quite a separate notion to liquidity. I don’t see any evidence of a liquidity crisis because central banks are supply liquidity (not via QE by via lending cheaply to banks) but perhaps this problem of a lack of collateral is causing financing costs to rise (how much banks have to pay to borrow money to fund lending). I don’t really see it, but even if true it’s only one possible explanation of uncertain quantitative significance.

Low Interest rates are supposed to stimulate the economy because people and firms thinks there is less point accumulating savings and more point spending. That, and people save money on mortgages etc. if index linked.

There surely is an optimal interest rate for the economy as a whole – right now it’s negative, that’s why we are up against the so called zero-lower-bound – we can’t achieve negative rates when negative rates are what would be needed to return the economy to full capacity utilisation. Or that, at least, is what people like Krugman have in mind.

As I put in a comment on Jon’s blog, that isn’t quite what I said. I said that the demand for “safe” assets, including high-quality government debt, is far exceeding supply, and that is why yields on high-quality govt debt are crashing. It’s also why interest rates on insured deposits are on the floor – as Tyler says, cash (in an insured deposit account) is also a safe asset. This is not so much due to restricted supply as increased demand, although QE does reduce the supply too. The issue is that fiscal austerity (particularly) restricts the ability of government debt to expand to meet the demand for safe assets. In my own post, to which this links, I point out that there are other solutions, such as guaranteeing wholesale cash deposits and rethinking the risk classification of certain corporate bonds.

Tyler, it is collateral liquidity in the shadow banking system that is the problem, not cash. I’d recommend you have a look at this post by Singh and Stella at VoxEU:

http://voxeu.org/article/central-bank-reserve-creation-era-negative-money-multipliers

Their focus is on whether or not QE is inflationary, but they also describe the effect of QE on collateral liquidity. I’m not personally convinced that QE reduces collateral flows that much – I think the problem is mainly one of increased demand which governments are unable or unwilling to meet, plus of course the fact that the financial system hasn’t yet found a replacement for the discredited MBS. It’s worth nothing though that in the Eurozone, the poor creditworthiness of many sovereigns does mean that there is a real shortage of good-quality government debt as collateral.

Sunny, that is a SHOCKINGLY bad headline. It doesn’t bear any relation to what Jon, Jonathan Portes or I actually said.

@ 13 Jon

You are confusing money supply, liquidity and supply of assets.

QE increases the money supply, but in banking (Basel III) terms doesn’t affect the amount of liquid assets a bank has to use a collateral – as govt bonds and cash have a similar weighting (indeed, cash has a higher weighting). The article you link to specifically states that…

“In this view, a central bank open market purchase changes the size of the liquidity fulcrum only if it swaps monetary base for assets that are no longer accepted at full value as collateral in the market. ”

The money supply is falling thanks mostly to being unable to lend as much thanks to higher reserve requirements via Basel III and individuals paying down debt and increasing their saings rate.

Debt servicing costs are reduced with such low interest rates, but the market isn’t stupid. It knows that longer term rates will mean-revert to higher levels, and if the total debt stock (or debt/GDP ratio if you prefer) is too high taxes will have to go up, or spending down, or the country simply go bankrupt. Italy and Spain are great examples fo this. .

@ 17 Frances

There doesn’t seem to be any stress in the shadown banking system when it comes to liquidity at the moment. Inflows are actually near all time highs…and given that most shadow banking type institutions can easily access repo markets there doesn’t seem to be a problem. I guess if supply of government bonds or cash was truly limited, or the money market/repo market stopped functioning again you might see a different story, but it very much looks like that there is more than enough liquidity available, and supply of government bonds is not contrained to cause any effect.

Remember doesn’t have to hold liquid asset reserves in the same way banks are because of Basel III.

Having read your article though, I have to say that you too are talking absolute rot.

QE replaces one safe asset with another. So no effect on the amount of safe assets in the system.

The repo market doesn’t only work in AAA assets. It trades in almost everything….I repo stuff on my books which trades only a few steps above junk every day. Likewise, equity, which is subordinate to all debt, is repo’d out in huge volumes every day.

Then we can look at the amount of debt issued out there. Even after QE the amount of government debt outstanding has increased over the last few years. That’s before you consider short term bills and notes. So how has QE even reduced the supply of govt debt, let alone safe assets???

“No, government debt is a GOOD for which there is a worldwide demand. We should produce as much of it as the world demands.”"

What the world is demanding at the moment is LESS government debt.

Liquidity isn’t a problem at the moment for the banking or shadow banking system. The ECB put 1tr EUR out via it’s LTROs…and the banks parked it straight back with the ECB.

The problem is not liquidity, it is solvency, and ultimately because of the vast amounts of debt accumulated there are many governments around the world who aren’t.

Tyler,

Then I presume you think that Peter Stella is also talking absolute rot?

Luis: By trade-off I meant that if fiscal stimulus produces growth, and low interest rates also act as a stimulus, and borrowing more drives up bond yields by reducing demand for them, then there’ll be a trade-off on whether it’s right to increase interest rates or increase investment.

Obviously you’d rather have low interest rates as well, but if we accept that investment can stimulate the economy then it may be the case that driving down interest rates as far as we can by not auctioning more government bonds is not the best strategy when it means not investing.

I don’t actually know whether this is actually the case. But the point I was making in the original article wasn’t so much whether that’s the best choice for growth, (though it looks fairly likely when our current strategy for credit creation isn’t working) but more that you wouldn’t have the liquidity problems that are coming with a dearth of AAA assets.

Tyler,

Well, of course, with a big enough haircut almost anything can be used as collateral. And the ECB has indeed been accepting a great deal of rubbish. But your belief that there is no shortage of collateral in the repo market is not shared by everyone. Far from it, actually. See this paper from Credit Suisse, which summarises the situation far better than my post:

https://doc.research-and-analytics.csfb.com/docView?language=ENG&source=emfromsendlink&format=PDF&document_id=955237241&serialid=1U7Rr6heRpieZmFPGqcN0OvJiPMUtQgvsNOjY5zB%2B6Y%3D

Their conclusions (on p.9) are as follows:

“Until output gaps close and private collateral begins to grow again:
- Underlying deflation risks will persist
- Central bank balance sheets AND FISCAL DEBT may need to expand further (my emphasis)
- Interest rates will stay in an historically low range, though not always as low as now
- The more macroprudential regulation is driven by hostility to shadow banking (money and credit chains backed by safe liquid collateral) the longer the conditions above will last”

I really suggest you read this. It’s an excellent paper.

Regarding the world demanding LESS government debt. That does not square with the evidence, which is that for highly-rated sovereigns debt yields are exceptionally low and even negative. The Eurozone is something of a special case: I would agree with you that the world wants less of the debt of distressed Eurozone sovereigns, but it wants MORE German debt and it isn’t getting it. The solvency issue you refer to only really applies to Eurozone countries, and I would say that the bigger concern in countries outside the Eurozone is actually economic growth. Poor or negative economic growth is itself a threat to sovereign solvency, of course.

I don’t think it is actually the act of printing money that is the problem per se, rather I think the problem is what we are doing (or perhaps more appropriately, not doing) with it. As I (by which I really mean “people better informed than me!” ) see it, all that has happened is that the QE money ends up bolstering banks’ balance sheets, rather than making it to the wider economy.

I actually think the BoE printing money is a good thing, if only the money was used to buy government bonds, and for the Government to put that money to use directly; specifically, stop laying off public sector workers (the private sector can’t employ them all), and start some big infrastructure projects (road maintenance/improvement, school building, and my personal favourite win-win investment; renewable energy infrastructure). Such actions would create many thousands of jobs for a number of years, reducing the burden of benefits, and giving consumers some money to spend, while encouraging overseas (and local) investment in the UK.

We’ve seen on numerous occasions since the 1930s, that when private sources of spending fall, and exporting is not an option (our neighbours have no money to spend courtesy of austerity there too), Governments step in to fill the demand gap, which creates a virtuous cycle, by putting our under-utilised productive capacity back to work -> creating jobs -> people with jobs (and job security) spend money -> etc etc

Usually at this point people cry “Inflation” or “You can’t solve a debt problem with more debt”, but first, a moderate amount of inflation (say 3-4%) is a good thing, it reduces the value of our debt (because we control our own currency, and borrow in that currency)! Second, the “debt” argument ignores whose debt caused the problem… it was a private debt problem, not a public debt problem (sure, you need to keep an eye on public debt, but we are so far away from being unable to repay are national debt that it is frankly a joke that people keep pointing to it – we are not remotely comparable to Greece, and even comparisons to France are a stretch). Unless of course, we continue with austerity, see no economic growth, or worse, contraction and the truly nightmarish scenario of deflation, which would increase our debt burden!

Ultimately, short-term Government borrowing can kickstart this economy and improve our infrastructure, and once we get back to solid growth, then the Goverment can adopt “austerity” measures to deal with debt and deficits, when private industry can actually get by on its own.

@ Frances

I strongly suggest you re-read that piece from CSFB…because you’ve drawn totally the wrong conclusions from it.

“Central banks are going far beyond Bagehot’s ancient advice of lending freely at a penalty rate against good collateral. Instead, they are lending at extremely low rates at below market haircuts against practically all manner of collateral for term. This is literally true in Europe under the LTROs, and implicit in the US, where large reserve balances and longer-term interest rate commitments are part of a package that promises to assure funding liquidity and support recovery. The BOJ and BOE are moving in the same direction.”

“A sharp fiscal easing then created a flood of safe collateral that caused the public shadow money (Treasuries, mbs, agencies) to soar, fully offsetting the contraction in private shadow money (corporate bonds, asset-backed securities, and non-agency mortgages).”

Also look at Charts 7 and 8.

What you have done is firstly conflate private sector illiquid collateral (households primarily, which according to CSFB is somewhat constrained) with the financial system as a whole. Then you seem to ignore the evidence in that CSFB report that says that credit easing has *increased* the amount of available collateral in the system….

Nor do the conclusions in the CSFB report argue what you are suggesting – not least because in addition to ignoring the data produced on the available collateral in the financial system, you confuse central bank balance sheets with government balance sheets – the former being liquidity and the latter being more debt.