Inflation, Deflation & QE

By Frances Coppola, Proprietor, Coppola Comment

Inflation is dead.  Well, in the US, anyway:



What is curious is that the US is doing QE. Lots of it. Which is supposed to raise inflation, isn’t it?   Then there is Japan. Japan recently embarked on an extensive QE programme designed to raise inflation to 2%. Here’s the path of Japanese inflation:


It’s very easy to see where QE started. It’s when inflation fell off a cliff. Well, ok, it might have done that anyway, I suppose. Correlation doesn’t equal causation, and all that. But it is curious.

Japan has, of course, done QE before. A look at the inflation path for the period 2001-2006, when Japan was doing QE, doesn’t suggest a close relationship between QE and inflation.


The initial impact seems to have been deflation, though again we could do with a counterfactual. But for the rest of the period QE seems to have had little impact on inflation. In fact a researcher at the IMF concluded that QE’s effect on inflation was small.

The UK does appear to buck the trend, since it experienced above-target inflation ever since commencing its QE programme, still the largest in the world relative to GDP although it is currently suspended. Though it is interesting that throughout 2012, when the Bank of England was doing QE, CPI was falling – it picked up in November 2012 when QE stopped:


But this isn’t quite what it appears. The UK’s CPI was pushed up by tax rises, student tuition fee increases (what on EARTH are they doing in measures of CPI anyway?) and above-inflation rises in near-monopoly privatised utilities which are subject to government price controls. Yes, really. Government not only allowed those above-inflation rises, it encouraged them in the name of investment – though why it thinks utilities should invest for the future now when it isn’t doing so itself is a mystery. And the other significant component of CPI in the UK is imports of essential items, notably oil. I suppose you could blame this on QE to some extent, because of its tendency to push up world commodity prices – but externally-driven cost-push inflation wasn’t exactly what was wanted, was it? Anyway, the poisonous combination of external factors and government mismanagement pushed inflation up while real incomes have been falling. How to squash domestic demand in one easy lesson…..the effect on retail sales, for example, is horrible.

When you strip those effects away from the UK’s CPI, it appears that inflation is dead there too. The Bank of England has been doing exactly this: it has “looked through” CPI to see the underlying deflationary trend. Not that it is planning any more QE at the moment. It is waiting to see how the Funding For Lending scheme works: this takes a different approach to reflating the economy involving new short-term government debt issuance rather than money – on the face of it a promising approach though to my mind it still relies far too much on damaged banks for its effects. But it seems the Bank is also thinking about negative rates.

Given the considerable evidence that QE does not raise core inflation in the countries doing it, it is a mystery to me why people are still talking as if it does. Bullard, for example, saying he thought the Fed’s QE programme should continue until inflation hit 2%. And the Bank of Japan supposedly targeting 2% inflation, though no-one really believes it (or do they? it seems “inflation expectations” in Japan are up….). And all the talk of inflation being a serious risk from QE exit, as if QE exit is going to happen any time soon. Yes, Bernanke is talking about “tapering off”. That isn’t exiting QE. It’s stopping it. Exiting QE (by which I mean returning the purchased assets to the private sector) is about as easy as ending capital controls and, like capital controls, will take years and years if it happens at all. And while inflation remains low there is no reason whatsoever to exit QE. If, in some future universe, inflation were to spike due to bank profligacy in the presence of enormous bank reserves, it is reasonable to suppose that inflation-targeting central banks would promptly drain those reserves by selling the purchased securities. Yes, I know the bond vigilantes dispute the existence of a market for such a large quantity of securities, but the private sector sold them in the first place, so why wouldn’t they buy them back? Really the idea of a buyers’ strike on central bank sales of securities makes no sense at all. The problem would be managing the pace of sales, taking into account impacts on inflation and on government finances.

So QE is NOT INFLATIONARY. Not now, and not ever. Let’s put a stake through the heart of the idea that central bank “recklessness”, as some people call it, will cause massive inflation.

The chart evidence above seems to show that if anything, QE has deflationary rather than inflationary effects. (yes, I know, correlation isn’t causation, counterfactual….). But it has been difficult to come up with a convincing explanation for this. This post is my first attempt. I do not pretend to have a complete answer, and for that reason I am creating an open space on the Coppola Comment blogsite where the debate can continue and people can pool information and ideas on this subject.  We must find the answer….because if I am right, then QE is one of the biggest policy mistakes in history.

In my view the apparently deflationary impact of QE is due to what Stephen King calls its “unwanted redistributive effects”, so is an indirect rather than direct effect. As the Bank of England noted in its review of QE’s distributive effects, QE benefits the asset-rich at the expense of the income-dependent. To understand this, it is necessary to look at the context in which central banks do QE. The typical picture is of a stagnant economy with high unemployment, a high household savings rate (actual savings or debt deleveraging), risk-averse companies that are reluctant to invest, and – crucially – a damaged financial sector.

QE supports asset prices. Clearly, this most benefits those who own assets – who tend to be the rich and the old. In the aftermath of the 2008 financial crisis QE prevented catastrophic deleveraging and economic collapse: it was an emergency response to a desperate situation.  But since then, the debate has moved on, the benefits of supporting asset prices now are by no means clear and there appear to be all manner of unintended consequences.

QE is supposed to nudge investors towards riskier investments by raising the price of safer ones. And it is succeeding in this: bond prices are at an all-time high and the stock market is reaching for the moon. This is supposed to reduce the cost of investment for those firms that can raise funds on the capital markets – i.e. larger companies. It doesn’t help small businesses who don’t have access to capital markets. That assistance was supposed to come through bank lending – but banks don’t want to lend to risky businesses at the moment. But it doesn’t seem that the reduction in borrowing costs for larger companies has encouraged them to invest for the future either. On the contrary, it seems they have been buying other assets….notably their own shares. There has been a swathe of share buy-backs in the corporate world, partly paid for with their extensive cash hoards and partly funded with cheap borrowing from the capital markets. Debt for equity swaps are all the rage. This does nothing whatsoever to improve growth, employment or income.

So we have a broken transmission mechanism. We often hear about a broken money transmission mechanism due to damaged banks, but we don’t often hear about a broken EMPLOYMENT transmission mechanism due to damaged corporates. Far from QE support of asset prices enabling companies to invest for the future and employ lots of people, it encourages them to indulge in financial jiggery-pokery to shore up their balance sheets and maintain directors’ incomes, while using high unemployment and government wage support systems as an excuse to force down wages. The sheer amount of spin from corporates about lack of investment opportunities is exceeded only by their constant moaning about quality of labour. You would think that the developed countries offer no opportunities for future profits, despite their skilled and flexible workforces and supportive infrastructure. And governments pander to this: they fund skills development programmes to compensate for the training that companies aren’t doing, they cut benefits to force people to take on more work – any work, however unsuited to their skill set and however badly paid – and they cut corporate taxes as yet more encouragement to invest and employ. Yet unemployment remains stubbornly high, productivity is poor and and hours of work are falling.

In the case of smaller businesses – and more generally in Europe, where businesses depend more on bank lending – the problem is the broken money transmission mechanism. The fact is that damaged banks won’t lend to riskier prospects, especially when they are under regulatory pressure to de-risk their balance sheets: interest rates on lending to small businesses remain high despite the considerable support extended to banks by governments in the developed world.  QE has provided banks with huge amounts of excess reserves – but it hasn’t given them a reason to lend productively. As with corporates, QE simply gives banks an opportunity to shore up their balance sheets and maintain directors’ remuneration. Banks, too, tried to spin their lack of SME lending as due to a shortage of good quality opportunities – but NIESR’s recent research gave the lie to that.

So the broken financial and corporate transmission mechanisms mean that QE does not reflate the real economy. That alone would make it pretty ineffective. But it doesn’t make it actually deflationary. To understand why the fact that it encourages hoarding and risk-averse behaviour means deflation, we need to complete the loop from companies starved of investment to an economy starved of demand.*

It does not matter whether a company is starved of investment because banks won’t lend to it, or whether it starves itself of investment through exploiting QE-induced distortions in the financial markets. The effect is reduced productivity, which pushes through to reduced wages. If the cost of capital is such that using low-cost labour is cheaper than investing in machines, unemployment may fall, but so will productivity as workers have to use less efficient tools. Similarly, if it is cheaper to use poorly-paid temporary, part-time, casual and self-employed workers than to recruit full-time staff, unemployment will also fall – but average hours worked will also fall. In both the UK and US we are seeing increasing under-employment and reducing productivity: unemployment is high in both countries, but not as high as it might be if average hours worked were higher. For me this indicates a pattern of low corporate investment in both capital and people.

Under-employment and falling productivity force down real incomes. Add to this the effects of fiscal tightening in both the UK and the US, which hit working people on middle to low incomes disproportionately, and to my mind you have a significant hit to aggregate demand which is sufficient to explain deflation in both countries. Both UK and US governments believe that monetary tools such as QE can offset the contractionary impact of fiscal tightening. But this is wrong. Fiscal tightening principally affects those who live on earned income. QE supports asset prices, but it does nothing to support incomes. So QE cannot possibly offset the effects of fiscal tightening in the lives of ordinary working people – the largest part of the population. In fact because it seems to discourage productive corporate investment, it may even reinforce downwards pressure on real incomes. And when the real incomes of most people fall, so does demand for goods and services, which puts downward pressure on prices, driving companies to reduce costs by cutting hours, wages and jobs. This form of deflation is a vicious feedback loop between incomes, sales and consumer prices, which in my view propping up asset prices can do little to prevent.

Ah, you say, but most people own assets, don’t they – through their pensions and in the form of houses. This is true. And it is fair to say that QE props up the value of both pension investments and real estate. But it depresses returns on savings.** Depressing returns is supposed to encourage people to spend instead of save. But when people are saving for their old age, and they see their savings whittled away in the form of below-inflation returns, they are likely to save MORE, not less. They will cut discretionary spending to increase pension saving. This I think is partly the cause of the apparently deflationary effect of QE in Japan. Japan’s households have high savings rates because they have to save for retirement as there is no state safety net. In the US and UK the effect may be less, because both these countries have substantial state pension & benefits provision for the elderly. But….those schemes are unfunded, and future taxation may be unable to support claims on those schemes. Therefore governments persistently “talk up” the need to save for old age. It seems likely, therefore, that the combination of increased pressure to save for retirement and depression of returns on savings is encouraging people in the US and UK to increase savings at the expense of discretionary spending too. Once again it seems that the combination of QE with other things is deflationary, though that doesn’t necessarily mean QE itself is.

Then there is real estate. Homeowners benefit from Government propping house prices with various forms of QE. This support is explicit in the US at the moment, since the Fed is buying agency MBS, though perhaps less obvious in the UK. But QE supports real estate prices even if only government debt is purchased. The rising price of safe assets pushes investors not just towards riskier investments, but also towards safer ones….most notably prime real estate, which has risen considerably in value. Supporting house prices through QE, coupled with low rate policies that (especially in the UK) have kept mortgage rates for existing borrowers very low, has prevented mortgage defaults and supported aggregate demand. But there is a cost. Rental values are high, which hurts people who don’t own property – the young, and people on low incomes. There is little evidence now of wealth effects from property prices increasing spending, as used to be the case prior to the financial crisis: people simply aren’t taking out second mortgages to release equity for consumer spending at the moment. Fingers have been well and truly burned, and uncertainty around jobs and income means that people are reluctant to take on more borrowing….after all, if your income is falling and/or uncertain, servicing debt is a constant worry, and taking on more (unless you have to) is madness.

Overall, therefore, QE looks deflationary to me. Or if not actually deflationary in itself, at least completely ineffective as an offset to contractionary fiscal policy and fear-driven hoarding by companies and households. And there is one particularly poisonous effect that I mentioned in passing earlier in this post. The excess liquidity caused by QE, and shortages of the safe assets being purchased, encourages investors not only into riskier assets, but also into alternative safe ones. There is a lot of cash hoarding going on…..and I’ve noted already that QE drives up the price of prime real estate. It also interferes with the pricing of metals, which has implications for production costs in manufacturing industries. And spikes in the prices of foodstuffs and oil have also been attributed to QE. If this is true, then QE is toxic, because it increases the price of the essential goods that people need in order to live. But as with all things QE-related, it’s not that simple….after all, commodity prices are falling at the moment. What is clear, though, is that QE causes enormous distortions in financial markets which are not fully understood and which create fear, uncertainty and instability in the financial system. This could be justified if its effects were evidently beneficial. But it is by no means clear that they are.

From where I stand, QE looks like a very bad bet indeed. The benefits are uncertain and the downside risks huge. In my view it should be stopped. But you may not agree – and I know that many people are much more positive about QE. If you believe that overall its effects are beneficial to the economy, please do comment. Or even submit a post of your own arguing the opposite case.

And here is a final thought. It’s all very well criticising QE, but what should we do instead? After all, we have stagnant economies, damaged banks, risk-averse corporates, highly-indebted households, high unemployment, under-employment, low productivity and falling real incomes. Doing nothing is not an option. If QE is a disaster, what is the alternative?



Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.
Frances Coppola

Frances Coppola

In a past life I worked for I write about them. Actually I write about finance and economics generally. And about anything else that interests me - so you may occasionally find posts on this site that have nothing to do with banking, economics or finance. In fact they might have something to do with music, since I'm a Associate of the Royal College of Music and a professional singer and teacher. I'm also an alumnus of Cass Business School, where I did an MBA with a specialism in finance and risk management

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  • rp1

    Any successful policy has to encourage spending e.g. real investment. Spending is the only way to beat deflation. In the past, the situation has degenerated and the world has solved this particular economic problem by blowing things up.

    If we want to avoid that solution, I suggest that central banks tighten to flush speculative capital out of the system. Governments would have to support the population with spending and taxes would have to skyrocket.

    If that sounds like a return to the 1950’s, it’s because it is. The developed world has to switch from debt and deflation to income and inflation. If we can do it without a #$% war we will be prosperous indeed.

  • SMOB

    Great article thank you. Isn’t the goal to raise aggregate demand? Monetary Policy is nullified during a balance sheet recession? What that leaves us is Fiscal Policy?

    In other words, when the private sector (house holds, companies and financial institutions) balance sheets are under-water they have no desire to borrow or lend at any rate, so the Government Sector needs to act as creator of money of last resort!

  • LVG

    Good read. Thanks. Cullen, do you agree with Frances on all these points?

  • Frances Coppola

    The goal is indeed to raise aggregate demand. My argument is that QE is not effective at this because it only improves the welfare of people with a low marginal propensity to consume. When coupled with fiscal policies that reduce the real incomes of those with higher marginal propensity to consume, the overall effect is reduction in aggregate demand. QE is not necessarily deflationary in itself, therefore, but it can’t shield economies from the effects of deflationary fiscal policy. You could say the real problem is that it isn’t inflationary.

  • Brick

    I pretty much agree, but I think you have missed an important deflationary effect which is the reduction in the amount and increase in cost of safe collateral due to QE. This effectively squeezes the shadow banking system and stunts capital flows.As discussed at the following links.

    I do however think you are wrong about QE being out right deflationary.My opinion is that it depends on its size and duration and the base interest rate. It may actually be a useful tool for limiting bubbles during normal interest rate environments.

    The argument presented here about the affects of QE on Commodities seems a little vague. If you take into account the fictionalization of commodities through the likes of ETF’s they could become a safe asset substitute, but then so can certain currencies (Swiss Franc) or investment opportunities (China maybe). You end up with volatility as money switches from one form of substitute safe asset to another. Each run up and switch incurs losses which can in themselves be deflationary.

    If QE is deflationary at this point then can we argue that the end of QE would be inflationary. Perhaps removing the shackles from capital flows in the shadow banking system will see vast outflows to emerging economies, forcing currency moves and bankruptcies there.Perhaps it will be inflationary and the Fed will be late getting inflation back under control.

    The idea of unwanted redistributive effects, is probably not going to be unpopular in economic circles, because in a way it is arguing that changing sectoral balances has uneven effects in the real economy and you would need specific policy to change the relationships between private sub sectors.

    A possible policy is to print and destroy money based on wage inflation and unemployment operating through reductions and increases in household tax. Potentially this would scare the markets through inflation expectations, and scare politicians because they would not be able to lavish money on pet projects during the good times.With a fixed framework outside of politicians control, with a mandate to both destroy and create money, perhaps it could work if it was sold properly. I think some businesses at the moment would swap a little credit availability for an increase in demand and reduction in pension liabilities.

  • jt26

    Francis, would you consider the Fed QE of MBS to a be a form of funding for lending? Looking at WFC’s recent 10-Qs they are spinning off most of their new mortgage loans. But, it’s not clear what the net effect is: according to FRED, total mortgage liability is still decreasing but perhaps the specific MBS targeted by the Fed is increasing (consistent with FNMA increases in profits).

  • Tim

    Isn’t it possible that QE is actually inflationary despite the broken transmission mechanism, but the deflationary tide is so powerful that the present QE is only strong enough to slow the deflation rather than actually reverse it? In other words, without QE, we may be still in a deflationary environment rather than the disinflationary one we are generally in. Maybe the deflationary spasm we experience in 2008-09 was only the first wave. It’s possible that QE could just be doing a better job at creating inflation in some areas like real estate, stocks, and bonds than others like commodities and wages.

    And what happens if the transmission mechanism gets fixed such that we start to see it have more of an impact on the real economy versus the markets? I’d expect inflation to pick up and potentially kick us from disinflation to actual inflation, stagflation, or possibly (though not necessarily) hyperinflation.

    It seems to me the choice is between pulling back on QE to get deflation, continuing QE as is with the broken transmission mechanism to get disinflation, or more QE and/or fixing the broken transmission mechanism to create inflation, stagflation, and/or hyperinflation. The markets and economy will go where they need to go regardless of what central banks and governments want, so shouldn’t they just get out of the way and let it happen (maybe intervening to slow the deflation so that it happens as a gradual unwind rather than a sudden collapse)? The only question to me is how the markets and economies will get there.

  • ram

    Very good post and discussion. Thank you. Not sure I understand all the nuances here as an engineer. It seems to me that we would be better off sending a check in the mail to all income earning citizens and have this taper down to zero at say $100K. So what if they pay down debt? if we do this long enough, they will start buying things that they need and then things that they want. The simple truth is that the large companies of the world like P&G cannot grow or survive if people were not making enough money to buy their products.

  • shawn

    Why do we see a downward movement in the price of bond funds recently (BOND, DLTNX, MINT, VCSH ect…). Certainly not due to increasing default rates. Seems as though the bond market is pricing in some inflation. What say you?

  • johnw

    QE achieves an increase in the monetary base (consisting of ex nihilo created debt free money) whilst the broad money supply (consisting of ex nihilo created interest bearing debt money) contracts. The process has the effect of maintaining the aggregate money supply in equilibrium, whilst at the same time having the beneficial effect of reducing the amount of debt in the system.
    But, as you have correctly identified Cullen, the transmission effect has faltered, and instead of this new money finding its way to the consumer, it has found its way straight from the printing presses of the US Fed and the BoE into essential commodities, bonds, equities and real estate causing those prices to inflate but, alas, the effect of this has failed to translate into increased demand in the productive sector resulting in decreased productivity and all the other damaging effects which you also correctly identify.

    Therefore Cullen, I agree that QE has deflationary, and unintended, consequences.

  • Tom Brown
  • bart

    “So QE is NOT INFLATIONARY. Not now, and not ever.”

    Horse puckey, unless your definition of inflation doesn’t include the stock market. US stocks are actually in hyperinflation mode since 2009, per the IASB definition of doubling in 3 years.

    Money CAN NOT be created like QE etc. does without causing substantial inflation somewhere. Not now, and not ever.

  • Cowpoke

    “QE benefits the asset-rich at the expense of the income-dependent”

  • Johnny Evers

    My question is: When the asset rich go to cash their investments, who will buy them?
    The Fed?

  • http://pragcap Michael Schofield

    Usually the rich dump them on the income-dependent just before the big drop.

  • johnw

    I agree!

  • Frances Coppola

    In a way, yes, though it’s nothing like the UK’s “funding for lending” scheme which is actually a collateral swap involving new T-bills rather than reserves.

  • Frances Coppola

    Why do you think QE is inflationary when the evidence for that is zero? I know it is hard for people to break away from the idea that increasing the monetary base necessarily means inflation, but really that is not the case – especially when the increase in the monetary base is 100% balanced by decrease in other forms of financial asset that are extensively used as collateral for funding transactions. Really it’s a wash, and therefore the base case should be that ceteris paribus there is no inflationary or deflationary effect.

  • Frances Coppola

    My definition of inflation as used in this post does not include the stock market. I think I made it clear I was talking about consumer price inflation.

    QE is INTENDED to cause inflation in the stock market. If it is doing so – and it seems that it is – then it is doing its job. My complaint is that this stimulus does not find its way through into jobs, incomes, lending in the real economy because of broken transmission mechanisms. I would have to say that my “straw man” argument that QE is actually deflationary in itself was “not proven” in this post, but it is fairly clear I think that when transmission mechanisms are broken and fiscal policy is contractionary, the effects of QE are inflation and instability in financial markets and deflation everywhere else.

  • Frances Coppola

    Taking apart Scott Sumner is not for the faint-hearted!

    Having said that…the Sumner Critique essentially argues that fiscal stimulus doesn’t work when the central bank is targeting inflation, because as soon as inflation starts to rise in response to fiscal stimulus the central bank will tighten policy, choking it off. This is somewhat at variance with Wallace & Sargeant’s contention (“Some Unpleasant Monetarist Arithmetic”, 1981) that a central bank is powerless to counteract excessive spending by a profligate government “after the event” – that’s the argument for monetary dominance. My view is that as the path of future inflation from fiscal policy is set when government declares its spending intentions, not when it funds them, the reason for Wallace & Sargeant’s despair is that the central bank would be intervening far too late. The Sumner Critique holds when the central bank inflation target is set in advance of government spending plans (i.e. monetary dominance) AND is credible. It is all about expectations, really. Sumner is essentially saying that the Bank of Japan’s “commitment” to 2% inflation is not credible and therefore the expectation will be “no change”. We shall see.

    I completely agree with Sumner about the need for supply-side fiscal stimulus, though we have to be a bit careful about Ricardian effects if the stimulus is seen as short term. But that sort of stimulus is particularly sensitive to central bank action, so it is essential that there is accommodative monetary policy as well. If monetary policy is tightened to choke off inflation arising from such supply-side stimulus, clearly the whole thing is a waste of time.

    The UK Chancellor is using the same argument the other way round – he thinks that as monetary policy dominates fiscal policy, the economic effects of a fiscal consolidation would be negated by loose monetary policy, so public borrowing could be reduced without significantly affecting economic performance. I agree that this follows from the Sumner Critique, but that assumes that transmission mechanisms are working normally. If they are not, then in my view the Sumner Critique does not apply: monetary and fiscal policy operate independently of each other because they affect different parts of the economy, and the result is inflation in asset prices, falling real incomes and a stagnant economy. As indeed we have in the UK.

    The Uneasy Money blog is talking about the effects of forward guidance, really – so back to expectations.

    Sorry about very long comment, Cullen!

  • Tom Brown

    Thanks for your detailed response Frances. The light in the bulb above my head is flickering ever so slightly on this stuff… Being a somewhat superficial but regular reader of Sumner and Glasner, I recognize your summary of their positions as being compatible w/ my own understanding. However, I’m not familiar with “Wallace & Sargeant” or “Ricardian effects.” I guess I’m surprised at the level of agreement you seem to have with them… I read you post as being more skeptical. But perhaps that get’s back to your statement regarding the UK Chancellor:

    “but that assumes that transmission mechanisms are working normally”

    Sumner usually assumes this is the case, doesn’t he? But you sound more skeptical in general. True?

  • Tom Brown

    I asked David Glasner what he’d do (if he had control of the Fed and fiscal policy) to hit the 2% inflation target that the Fed has been undershooting, and his reply to me is here:

    Which I’ll reprint for convenience:

    “Tom, Announce that the size of asset purchases will continue to increase until the inflation target it met and will be kept at least that level for a fixed period of time. I have no particular opinion about the asset mix. On fiscal policy, see my reply to Becky above.”

    He extended that strategy to being valid for hitting an NGDPLT in a subsequent comment on that post.

    So what he’s describing is QE essentially, right? Except with some added bits like announcing the goal, and increasing purchases every month until the goal is met, and then leaving the level of purchases fixed for some pre-determined amount of time after.

    So do you think that he’s wrong about Monetary policy here? On fiscal policy, he essentially says “yeah, lets do that too.” There’s a little daylight between Glasner and Sumner on fiscal policy:

  • Frances Coppola

    The “added bits” are the whole point. It’s the commitment to the goal that matters for credibility.

    He’s essentially saying that when monetary policy is immobilized due to the ZLB, fiscal policy helps to break the deadlock. Bernanke has been suggesting much the same. Although Glasner is flirting with the idea of negative rates….

    Where he departs from Sumner is in suggesting that fiscal policy may reinforce monetary policy. That, I would agree with – especially when transmission mechanisms are a problem. Fiscal policy can sometimes reach the parts of the economy that monetary policy cannot reach.

  • Tom Brown

    So putting aside fiscal policy (say nothing is done in that regard) I still get the impression from Glasner thought that he thinks the monetary policy he describes here (with the “added bits”) could be used to raise inflation to any level desired (in my original question I asked about values from 2% to 10%) or to perform NGDPLT. Do you agree with that?

  • Tom Brown

    I didn’t see the negative rates part… but I know he’s not a fan of positive rates. Nor is Sumner.

  • Frances Coppola


    Ricardian equivalence basically says there is no point in making short-term tax cuts because people will just save the money instead of spending it since they know they will have to pay it back later.

    Here’s Wallace & Sargeant’s paper. I warn you, the math is fearsome (“arithmetic” it certainly isn’t):

    Sumner does indeed assume that transmission mechanisms always work. But I don’t think he’s right about that. Damaged banks, over-indebted households & corporations, and nervous investors all impair transmission mechanisms in my view.

  • Frances Coppola

    Quite possibly – largely as a result of Abenomics I would say. There is a widespread belief that QE is inflationary, so it’s not surprising that QE depresses bond prices at least to start with! But inflation expectations don’t always translate through into actual inflation.

  • Tom Brown

    Great, thanks for the clarifications. Does it sound like Glasner’s ideas about the transmission mechanisms are similar to Sumner’s? How about Nick Rowe?

    “the math is fearsome”

    I’m OK with math, but that sounds about as appealing as ghost pepper eye wash…. no thanks! (but thanks for the link anyway!)

  • Frances Coppola

    I don’t agree that monetary policy has magic powers to achieve any given level of inflation or NGDPLT, and certainly not when transmission mechanisms are broken as I believe they are at present. I think that is taking monetary dominance to ridiculous extremes. Fiscal policy does have a role to play, especially when monetary policy is hampered by the ZLB or by transmission problems.

  • Tom Brown
  • Tim

    The supported/increased asset prices that you mentioned (stocks, bonds, commodities, and real estate) are why I think QE is inflationary. I also believe the non-price-related deflationary dynamics (hoarding, wage weakness, etc.) you pointed out would still be present. Basically, I’m approaching things from the view of, “What if QE was removed and replaced with nothing?” If QE is removed, I think many of these asset prices would fall and the already-present non-price-related deflationary dynamics would be exacerbated as a second deflationary death spiral kicks in. I think the disinflationary environment we are presently in would become outright deflationary in the absence of QE. My view is QE is presently the difference between us being in a deflationary environment a la 2008-09 and a disinflationary one a la 2009-present. That QE takes us from deflationary to disinflationary in its present form is why I think QE is inflationary. It moves us more away from deflation than it moves us towards deflation.

    That monetary base increases don’t automatically lead to inflation is why I asked about what happens if the transmission mechanism improves and QE starts to find its way more into the real economy versus the financial economy. I believe that would be inflationary. That’s also why I outlined that less QE leads to deflation, QE as is maintains disinflation, and bigger QE and/or a more efficient transmission mechanism into the real economy leads to inflation.

  • Tom Brown

    OK, good. Now do you agree with my interpretation of Glasner: i.e. that he thinks monetary policy can do it alone?

    It’s pretty clear where Sumner stands…

    “There is no example in history of any fiat-money central bank that tried to create inflation and failed.” -S. Sumner

    It seems like he might have to revise that a bit given that even he’s now skeptical Abe-nomics will get the Japanese to 2% (see his point 2 here):

    … of course he effectively says now “well they’re not really trying.”

  • Frances Coppola

    Nick is usually rather more nuanced than either – as indeed your link shows. My main problem though is that market monetarists ignore the essential role of banks in transmitting monetary policy and therefore miss the logical conclusion that damaged banks means monetary policy is less effective. Richard Koo understands this but to my mind goes too far – diminished effectiveness is not “ineffective”. My view is that when monetary policy is hampered by damaged banks (and maybe damaged companies and households too), complementary rather than antagonistic monetary and fiscal policy is the best approach.

  • Cullen Roche

    I’m late to the good discussion. The MMers basically think you can move the needle by having the central bank commit to the Chuck Norris effect. In essence, if the Fed threatens to do something then the pvt sector will respond accordingly. The transmission mechanism appears to be mostly psychological (a scare tactic of sort), but also fiscal via the central bank. For instance, Sumner has stated that the Fed should just buy everything. But that would be fiscal policy. If the Fed started just crediting my bank account because I sold them patches of dirt then that’s the Fed doing fiscal. It’s very different than buying outstanding govt bonds for instance. So, their big bazooka is actually fiscal policy. Although, ironically, Sumner says fiscal policy sucks (ha).

    Personally, I think monetary policy like QE is only effective when it has a Bruce Lee effect to back up the Chuck Norris effect. As Lee once said, “saying is not enough, you must do”. The Fed can set overnight rates not because it says the rate, but because it can protect the rate. LIkewise, if the Fed wanted to set the USD/EUR it would do so not by simply saying the rate, but by protecting it. So the Fed’d big bazooka is being able to do. If it can’t influence lending through the interest rate channel (as it’s having trouble doing now) then it must become a fiscal entity of some sort. That’s where Sumner seems confused in my opinion, but the Fed isn’t legally allowed to buy plots of dirt from me so who cares anyhow? So QE is limited to this very inefficient form of roundabout impacts via things like a portfolio rebalancing channel….

    PS – NEVER apologize for leaving comments. Your stuff is great so the contributions are always welcome.

  • Frances Coppola


    Yes, QE causes inflation in asset prices. I don’t dispute that – in fact I said in the post that QE props up asset prices. It’s supposed to, and it does it pretty well. But in the post I was talking about consumer price inflation, and that is what the charts show. There is no evidence that QE has any significant influence on consumer price inflation.

    Yes, if the transmission mechanisms started to work and money got out into the economy, the effect would be rising consumer price inflation. The trouble is, we’ve only ever used QE when we are in a deflationary environment following a financial crisis – which, as it seems to rely on transmission mechanisms working properly, to my mind means it isn’t going to work as a demand stimulus.

    In 2009, when the economy was collapsing at a frightening rate, I agree that QE – along with other measures – did a good job in preventing a deflationary death spiral. But I’m not convinced it is either necessary or helpful to prop up asset prices like that now – and definitely not as a supposed counter to unnecessary and damaging fiscal tightening.

  • Frances Coppola

    Thanks Cullen!

    The portfolio rebalancing channel is looking rather battered too, frankly. Woodford trashed it at Jackson Hole. Though Bernanke is still arguing that QE works by suppressing the term premium, even though the term premium is negligible for a sovereign in good standing with a deep liquid market for its debt. Clutching at straws, I’d say.

    Woodford concluded that the “psychological channel” was the only one that had any chance of working and even that was weak at very low interest rates. He then went on to recommend NGDP targeting and a much greater role for fiscal policy. Trouble is, everyone ignored that and homed in on his endorsement of “forward guidance”.

    I think all the MMers find it difficult to accept that there are circumstances under which monetary policy doesn’t work well. The confusion between fiscal and monetary policy to my mind arises because they think if a central bank does something it is always monetary policy, even if it has fiscal effects.

  • Tom Brown

    “My main problem though is that market monetarists ignore the essential role of banks in transmitting monetary policy”

    You may well be correct about that… I don’t really know enough to tell, especially w/ regards “damaged banks.” Certainly Sumner has argued that banks don’t belong in macro:

    But I’ve come to believe that none of these guys (Sumner, Rowe, Glasner) are *complete* dopes about how banks work… well at least not Rowe or Glasner. They both know very well where inside money comes from (that banks create it), that the money multiplier is a myth (w/ fiat money systems), etc. Even Sumner agreed w/ my list here:

    …when I scolded him about stating (on the radio!) something which implied banks could “lend out reserves.” Also Rowe and Glasner even acknowledge that banks are not reserve constrained in their lending, at least in the short term (e.g. between Fed meetings).

    What’s strange is that Rowe, even acknowledging all that, still insists that banks are really just intermediaries… … though he claims he doesn’t subscribe to the bank-ignoring “loanable funds” view. I have a really hard time understand Rowe on this. I went through an example with him of a guy buying a house and the bank creating the deposit for him (via double entry accounting) when he took out a mortgage, but he still said something to the effect that “The buyer could have just issued the seller an IOU directly w/o the bank… thus the bank is just an intermediary.” 8O

    All these guys sound more “advanced” in their thinking about banks than Krugman did in his battle w/ Keen a few years back. Although I think Krugman has perhaps advanced a bit in his views since then? I’m not sure.

    I agree w/ you about complementary vs antagonistic monetary and fiscal policy. Glasner would be on board. Even Sumner acknowledges the benefits of “supply side” fiscal policy and that austerity needs to be compensated for via monetary policy (thus implying there’s something there that needs compensating for). It seems policy wise there could be some agreement between NKers and MMers on a complimentary approach… despite all the rancor between these two camps.

    It’s the traditional monetarists (e.g. John Cochrane) and the Austrians that are least likely to be on board I think… even though I understand there are at least a couple of NGDPLT advocates amongst the Austrians! (I have no idea who)

  • Cullen Roche

    Yeah, the one thing I think the Fed could do is essentially suppress the long bond to nothing. So, if they set the long bond at 1% then mortgage rates would collapse and you’d basically get a huge housing frenzy or leveraged asset frenzy because money would then really become just like bonds. But again, that tends to exaggerate asset price moves as we’re seeing in some markets now. So, it’s not that I think the Fed is powerless, but that there are much better alternatives. Fiscal policy not only solves the MMers safe asset shortage, but can do so in a much more targeted way than just waiting on the pvt sector to solve the problem with its own risky assets.

    I think we’re all on the same page here as far as QE is concerned and we just see the world through a very different lens than the MMers do.

  • Frances Coppola

    I suppose, having worked in banks a lot, I have a bit of a problem with people who think that banks are simple intermediaries or conduits. MMers (and others) seem to think that if you set the interest rates right, banks will always lend. No they won’t, unless the risk/return profile is right for them. And for banks whose balance sheets are stuffed full of NPLs, the risk/return profile is almost never right. I know it seems ridiculous to suggest that a firm whose entire business is lending might choose not to lend, but when their balance sheets are very risky and monetary policy is supportive, that is exactly the choice they make. They can make just enough from their existing loan portfolios to pay their bills, the central bank ensures that they don’t suffer liquidity crises and QE props up the value of their assets. New lending not only is not necessary to their survival, it actually makes them more likely to fail.

    I wish people would understand this. Damaged banks DON’T LEND. And without bank lending, no new “inside money” is created – in fact as banks reduce their NPLs and shrink their balance sheets, inside money is gradually destroyed. No amount of expansion of the monetary base can compensate for the collapse of inside money when banks are severely damaged.

  • Frances Coppola

    I would have to say that central banks’ track record of hitting inflation targets isn’t that great, actually. They get “somewhere near them”, then think up excuses as to why they didn’t quite get there. Just look at the Bank of England over the last 5 years.

  • Frances Coppola

    And as for central banks trying to create inflation nad failing….show me an example of a central bank trying to CREATE inflation? Except for the Bank of Japan, of course. And we know how that ended.

  • Jim

    Hi Francis
    The broken transmission mechanism that you mention. Can you describe the mechanism more fully? I read Bill Mitchell’s QE 101, the point being that for private banks, loans create deposits (as ever). Banks don’t lend the reserves held by the central bank. So, I guess the reserve mechanism is not part of that transmission mechanism. It is not an alternative either. It’s not a big question, but I’d be interested in what you think.
    Best wishes and thanks for a stimulating article.

  • bart

    So QE is actually INFLATIONARY, and the “not now, not ever” is false.

    It’s my belief that it’s both false and dangerous to avoid consumer inflation issues by pretending that asset inflation doesn’t affect consumer inflation. It’s partly about monetary lags and velocity created consumer inflation too. In other words, asset inflation can and will affect velocity, which will affect consumer inflation.

  • Frances Coppola

    No, Bart. Within the parameters I set in the post, it is correct to say that QE is not inflationary as far as consumer prices are concerned. Not now, and not ever. Asset prices can inflate and deflate considerably without ever really affecting consumer prices – as indeed we saw during the Great Moderation. The broken monetary transmission ensures that asset price inflation does not feed through into consumer prices now, and the central bank is responsible for ensuring that asset price inflation will not feed into consumer price inflation in the future either. You may believe that the central bank won’t be able to control inflation in the future. But if that’s what you think, your natural home is Zero Hedge. And you have a major disagreement with Scott Sumner.