It turns out that Milton Friedman was a big fan of QE.  He even recommended it for Japan.  In a 1998 paper he described exactly what he would do for the Japanese – just raise the money supply.  He said (thanks Barry Ritholtz):

“The surest road to a healthy economic recovery is to increase the rate of monetary growth, to shift from tight money to easier money, to a rate of monetary growth closer to that which prevailed in the golden 1980s but without again overdoing it. That would make much-needed financial and economic reforms far easier to achieve.

Defenders of the Bank of Japan will say, “How? The bank has already cut its discount rate to 0.5 percent. What more can it do to increase the quantity of money?”

The answer is straightforward: The Bank of Japan can buy government bonds on the open market, paying for them with either currency or deposits at the Bank of Japan, what economists call high-powered money. Most of the proceeds will end up in commercial banks, adding to their reserves and enabling them to expand their liabilities by loans and open market purchases. But whether they do so or not, the money supply will increase.

There is no limit to the extent to which the Bank of Japan can increase the money supply if it wishes to do so. Higher monetary growth will have the same effect as always. After a year or so, the economy will expand more rapidly; output will grow, and after another delay, inflation will increase moderately. A return to the conditions of the late 1980s would rejuvenate Japan and help shore up the rest of Asia.”  (You can read Friedman’s entire piece here.)

This is simply not correct.  Now, I know it’s blasphemy for me to claim that the great Milton Friedman doesn’t understand the modern monetary system.  Then again, this is the same man who is largely responsible for the free market ideas that helped deregulate the banking system, financialize the US economy, and convince everyone that monetary policy was the end all be all.  Of course, monetarism is now dead to the point where its followers have been forced to rebrand it.  But never mind all of that.  The systematic deconstruction of the US economy via these misguided economic theories are just a minor detail, right?   Right?

Anyhow, Friedman’s statement makes one thing very clear.  He thought the Fed could “print money” via QE.  In the words of Richard Koo, Milton believed the apple salesman just needed to add more apples to the shelves during his apple sales drought.  Of course, that’s not the cause of the apple salesman’s drought.  He doesn’t need more inventory.  He needs more customers.  The lending markets work no differently.  Besides, banks never loan reserves anyhow so Friedman’s premise is flawed from the beginning.  But this myth of the money multiplier is one that even the Fed appears to only just recently be noticing (see here for more).

More importantly though, the Fed doesn’t “print money” during QE.  Fed operations such as this one involve asset swaps that help them target interest rates by altering reserve balances.  Interestingly, in the case of QE, they’re not even succeeding in their efforts to control interest rates because the policy is implemented without any sort of specificity.  Like policy at the short end, monetary policy is always about price and not size.  But QE as is implemented, names a size and not a price as they do at the short end.  This is the primary reason why there is even debate about the real interest rate impact.

What they’ve essentially done via QE2 is swap 0.25% paper for 2% paper and call it a day.  The banks aren’t “more liquid” than they were before and since they don’t lend reserves they don’t have more firepower with which to lend.  All QE really seems to do is generate mass confusion and a portfolio rebalancing effect which appears to cause disequilibrium between markets and reality.  In addition, it’s important to remember, helicopter drops are fiscal operations, not monetary operations.  You would think that more of this would be hotly debated on a daily basis after QE2’s fantastic failure, but the myths persist.  It seems that Milton Friedman had it completely wrong.

Mr. Friedman finished the above piece with an interesting quote:

“After the U.S. experience during the Great Depression, and after inflation and rising interest rates in the 1970s and disinflation and falling interest rates in the 1980s, I thought the fallacy of identifying tight money with high interest rates and easy money with low interest rates was dead. Apparently, old fallacies never die.”

Indeed they don’t.  Expect to hear lots of chatter about “money printing“, “debt monetization” and other fallacies in the coming weeks….



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.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • FXTrader

    Friedman was a great economist and I think he had the right intentions, but his misunderstanding of the monetary system led him to some very bad conclusions. Even he questioned his own theory at the end of his career.

  • DanH

    Cullen, thanks for your work on QE. Do you think operation twist will have any impact on the markets?

  • Cullen Roche

    Depends. If the market thinks they’re printing more money then we could see a big market move. If they come out and say they’re selling 300B in short and buying 300B in long then we’ll probably hear the media refer to it as a neutral program. In which case, operation twist will float in the wind and the economy will do whatever the economy does based on other factors…..and the markets will respond accordingly.

  • Neil Wilson

    Come off it Cullen. No finer people than the Bank of England have stated that the UK’s QE was a screaming success.

    “Drawing on a range of different approaches the analysis suggests a peak effect on the level of real GDP of between 1½ and 2% and a peak effect on annual CPI inflation of between ¾ and 1½ percentage points. Further analysis suggests that these asset purchases may have had roughly an equivalent impact on inflation as a cut in Bank Rate of between 150 to 300 basis points.”

    You guys in the US clearly need to learn how to do QE properly from the masters of the strategy in the UK.

    The fact that the analysis uses more ‘mights’, ‘shoulds’, ‘coulds’ and ‘assumes’ than your average seaside palmist is entirely beside the point.


  • MMT Newbie

    I would suggest to expect the latter: that the market will see it as amounting to nothing.

  • Cullen Roche

    I just love event studies! You can basically prove anything you want. Oh, the sun rose every day that QE was implemented. Well surely that must mean that the sun rises because of the Federal Reserve, right (or in your case the BOE)? Am I right? Of course I am. The event proves it!!!!

  • Pete

    I read your MMT primer, and also a lot other stuff. I have a lot issues with MMT, but let me ask you about the QE2. You said QE2 is a swap, which means Fed buys one and sell the other. No new money is created. How can that increase Fed balance sheet ? or you don’t think Fed balance sheet is increased? If Fed balance sheet is increased, where does it get the money to increase balance sheet?

  • reader xyz

    Mr Roche,

    Is it possible that more QE is need for the Prime Broker System?? Since the largest Prime Brokers are Credit Suisse, Deusche Bank & other big European institutions. A $2 billion loss by UBS can’t really help the system. I’m not sure, but I believe that the Prime Broker System has replaced the Commercial Banking as the driver of the economic system & that this system is now the focus of regulators. Am I close?

  • chewitup

    But, but, Milton, but Milton Friedman, but, but, uh, Milton, I mean Milton Friedman said, uh, University of Chicago, but…

  • LVG

    The Fed never gets money from anywhere. They’re the monopoly supplier of reserves to the banking system. But don’t confuse this for money printing. When the Fed implements QE they are removing bonds from the balance sheets of banks and replacing them with reserve balances. The bank is no more liquid than it was before. QE is no more money printing than any other Fed operation.

  • KarmaPolice

    I always get a chuckle when I hear people make the comparison with the US and the lost decade of Japan. They are completely different cultures.

    Where as you have the Japanese as multi-generational savers compared to the Americans as the consumate consumers.

    I believe it is incorrect to make the correlation or expect the outcome to be similar.

    Never underestimate the power of quantitative easing on a market like the US. The final step out of the this tar pit is the easing of loan standards for housing and that is just about to happen.

    Richard Koo was right when he said the worst thing that could happen was a homogenous deleveraging, and that is exactly what happened in Japan.

    That is not going to happen in the US at that level. Not even close.

  • Cullen Roche

    I’ve discussed why we’re not exactly Japan. See here.

    But that doesn’t mean the dynamics aren’t very similar….

  • chewitup

    The biggest change is that the interest paid on the securities the Fed bought now goes to the Treasury instead of the previous owner banks. For QE2 this was about $80billion taken out of the non-government sector. The Fed exchanges Treasury securities at a higher interest rate for reserves paying 0.25%. So the Fed balance increased by about $80 billion. Essentially adding reserves for psychological reasons instead of interest rate support.

  • Mountaineer

    QE is an “asset swap” from the perspective of the banks. If you visualize a bank’s balance sheet, a typical QE transaction will debit its bond holdings and credit its reserve account. The transaction has the effect of shortening the average duration of the bank’s portfolio and lessening the amount of interest it receives. There is no change in solvency, the banks are merely substituting a longer dated government liability for a shorter dated government liability with a lower interest payment.

    The Fed’s balance sheet expands because they have purchased assets from the bank, along with a corresponding liability in the form of increased reserves. Increasing bank reserves does not equate to increasing the broader money supply as bank reserves can only be used in the settlement of interbank lending.

  • Cullen Roche

    For those interested, this is an appropriate speech for this post. Galbraith’s line “Truly I come to bury Milton, not to praise him” is one of my favorites of all-time. Great great reading here:

  • Woj


    Thank you the continued to efforts to increase knowledge and awareness about today’s ecomomic troubles and modern monetary theory. Based on my reading of Friedman (and Keynes), it appears the big factor glossed over by both was aggregate debt, especially in the private/household sector. Both seemed to believe aggregate debt would not restrict demand (or the ability to further increase debt). From this vantage point, lowering real rates should have had a greater effect. An interesting question is whether or not the Fed/Treasury have as much control over the money (credit) supply in today’s monetary system given the amount of bank credit running throught the system. Surprisingly I think Hayek actually alludes to this issue in Monetary Theory and the Trade Cycle. If this consideration were true, monetary policy might be even less effective than you’ve already laid out. Any thoughts on that topic?

  • djiddish98

    Do you know what the current savings rate is in Japan compared to that of the US?

    Or the average savings rate in Japan since 2000?

    I think US population growth vs. Japanese population growth is a definite difference, but Japanese savings doesn’t appear to be what it used to be.

  • KarmaPolice

    Thank you Mr. Roche for the link.

    “The real recovery is coming, the world is not ending and if you plan properly now you might just be prepared to ride the back of the next great period of economic growth.”

    I am more optimistic than 2013.

    Housing has bottomed and rental rates are rising. The media is still focusing in on the drecks of housing due to its titillating factor which plays well.

    The dynamics maybe similar but the outcome will be much different. Uncle Milty’s analytics maybe more applicable for the US and I believe that they are.

  • Cullen Roche

    A lot of the neoclassicals have this misperception that leads them to that conclusion. For instance, Paul Krugman (die hard Keynesian) and the quasi monetarists all says “there is a debtor for every creditor”. The implication is the pvt sector debt levels don’t matter and that it’s generally a money demand problem that causes monetary policy to have reduced effects at the zero bound. But this is a colossal error in my opinion. It implies that all debtors and creditors are the same and that they utilize financial instruments in the same manner. But anyone who is familiar with Minsky’s financial instability knows that this is just not true. Banks are not even remotely comparable to other economic agents such as consumers. Especially in a consumer driven economy like the USA. It’s not a money hoarding problem. It’s a balance sheet recession at the consumer level where the engine of economic growth has been stymied by decades of money manager capitalism and ignorant fiscal policy.

  • Mountaineer

    In accordance with my ongoing policy I will now take this moment to once again mention that James K. Galbraith should be Treasury Secretary. Every day that passes with that smirking weasel Geithner occupying Galbraith’s chair is an affront to rational thought and an ongoing national disgrace. That is all.

  • Cullen Roche

    I think we have a few more years of muddle through. I still think my 2013 argument is realistic, but I love your optimism!

  • Max

    “The other set of fallacies, of which I fear the influence, arises out of a crude economic doctrine commonly known as the Quantity Theory of Money. Rising output and rising incomes will suffer a set-back sooner or later if the quantity of money is rigidly fixed. Some people seem to infer from this that output and income can be raised by increasing the quantity of money. But this is like trying to get fat by buying a larger belt. In the United States to-day your belt is plenty big enough for your belly. It is a most misleading thing to stress the quantity of money, which is only a limiting factor, rather than the volume of expenditure, which is the operative factor.” – John Maynard Keynes

  • Pete

    Treasury sells bonds to get cash to pay obligations, such as social securities. Someone with cash will have to buy. This is a real day by day transaction, like Dalio said. Treasury has to get the money somewhere, either recycling the cash from the Chinese, or primary dealers (commercial banks) or other traders. If none of these people will buy treasury or buy less, then Fed will have to step in to do it. when you say the Fed has a monopoly for reserve, you are saying regardless Fed will always has money (US dollar) to buy anything, which is true. It is only true when the seller will take the US dollar. This is a credibility issue, and the market is based on this credibility of this country. If the Fed is buying everything with its reserve of unlimited supply, the credibility is gone. Essentially, you want to fool all people all time. Nobody in history could have done that forever. If prosperity and wealth is like that, why don’t we give everyone a bucket of dollars every month or just credit everyone a million bucks every year? that will stimulate the demand well. Is this how MMT works?

  • Geoff

    “Helicopter drops are fiscal operations” is a brilliant line.

  • Cullen Roche

    This is two different issues that often get confused. Credibility is always an issue for a fiat currency issuer. The populace can always turn around and say “we don’t want to use your silly paper money anymore!”. But that has tended to happen only under very specific situations in which the public’s standard of living has deteriorated to the point where they essentially reject the govt’s money. I’ve studied the history of these events and they almost always tend to revolve around the same circumstances – losing a war, regime changes, productivity collapse, or loss of monetary sovereignty. None of those cases currently apply to the USA. Could something else occur to cause this decline in credibility? I guess. But when the day comes that you or other people don’t want their dollars, please let me know, because I have a feeling that myself and a few billion other people will still be seeking to do business with some of the corporations that are US based who output about 25% of the entire world’s GDP. Ironically, every hyperinflationist I know of, transacts in USD’s, buys their fancy suits in USD’s, buys their new cars in USD’s and owns a home denominated in USDs….But they make a living selling fear by telling people they shouldn’t own USD’s….Interesting conundrum there for the hyperinflationist living in the USA….

    As for the monetary ops. I fear you have it backwards. The USA must issue paper before anyone can ever pay taxes or purchase bonds. China’s purchases are a function of their trade policy with us. They buy US Tsys because they are a dollar accumulator and we tell them they can’t buy Chevron so they buy the only thing they can – Tsys. It’s not “funding” us. You might reread the primer to clarify these topics.

    Hope that helps.

  • nikko

    Friedman was “brains” behind moving the US off the gold standard by floating the dollar and thus giving birth to modern fiat (MMT) and killing off hard money Austrian doctrine. But he supported free enterprise and small government (minimal government spending) because he believed malinvestment would be the probable outcome.

    Everybody loves to argue with Milton, particularly when he isn’t there.
    George Shultz

  • Pete

    To be accurate, I think MMT is correct in the sense that it reflects the reality of our system. I guess my issue is that our system may end up in a total collapse, and I don’t really like the reality I see, not the MMT theory itself.

  • Peter D

    “I guess my issue is that our system may end up in a total collapse, and I don’t really like the reality I see, not the MMT theory itself.”

    Even a Porche can be driven into a ditch (but this is not a reason not to drive a Porche, right?)
    That said, what makes you so pessimistic? I usually find that people who think of collapse have pretty wrong ideas about the state of US Economy (usually something about the supposedly huge wasteful govt spending). I, for one, am afraid of wildcards like global warming and peak oil.

  • Pete

    Thank you. I went back to re-read the primer. It addresses all what I mentioned. I forgot what I read before.

  • Geoff

    Too bad “Helicopter Ben” has a such a nice ring to it.

    How about the Money Obomber?

  • Pete

    What I see is that more and more businesses are leaving this country, and more and more people are living paycheck to paycheck, if they have a paycheck. Blocks of building in downtown are empty. For sale or for lease signs all over. people with jobs are scared of losing their jobs. Everything in the grocery stores is going up. Gasoline is doubled in price, and people need to drive to work. Everything, except for salary and house price. At the work, if we don’t have enough to do, we send people home early. If we are busy, we don’t allow overtime. In this area, we had big companies in the past, now they are almost all gone. That’s what I see. I don’t know how we get out of this.

  • Austin

    I got a solid foundation in Economics from UT, but that was before JKG moved to Austin. Then I had to re-learn everything after reading an article by Dr. Pavlina Tcherneva (3 times) and discovering this site. Damn you, Cullen, you make my head hurt.


    ‘Modern Monetary Theory and Mr. Paul Krugman: A Way Forward’ by Pavlina Tcherneva

  • F. Beard

    Besides, banks never loan reserves anyhow so Friedman’s premise is flawed from the beginning. Cullen Roche

    Wouldn’t it be more accurate to say that banks never loan reserves to non-banks?

  • F. Beard

    More importantly though, the Fed doesn’t “print money” during QE. Cullen Roche

    If the Fed swaps FRNs for crappy assets then it has “printed money” since those crappy assets can no longer be used to sterilize those FRNs. No?

  • Peter D

    Pete, the problems that you’re seeing are mostly a result of the recession. Unless we’re very stupid about it, we’re not going to be in this recession forever. Yes, have have other problems – the political breakdown in this country comes to mind, as well as the mentioned ecological and resource problems. This is where the collapse can come from. Otherwise, the US is still an economic powerhouse, make no mistake about it. Seen this:
    “Made-in-China” Only 2.7% of U.S. Spending ?

  • Detroit Dan

    I agree. With Galbraith as Treasury Secretary, the world would be a far, far better place. Maybe in the future…

  • Detroit Dan

    F. Beard– I think you are right with regard to the Fed buying “crappy assets”. I tend to think of QE as buying Treasuries, as that is the standard. But again, you make a good point…

  • dimm

    you missed the wink at the bottom. that was not a “factual statement”.

  • Cullen Roche

    Are you trying to refute the idea that the sun rises because of the Federal Reserve and QE? Because I could easily whip together an event study “proving” this. ;-)

  • Different Chris

    I’m a pessimist still hope either of you is right. I think that shows why its better to be an optimist.

  • Rob

    Of course QE is printing money. If QE was just a “Treasuries”==Cash swap then why would a bank do the swap rather than just sell “Treasuries” to get the cash? The “treasuries” are either (a) crappy assets or (b) just a mechanism to allow the bank to buy more new treasuries without open market selling existing, i.e. facilitate govt deficit increases. Frankly I suspect it is both and neither are in the “common” interest.

  • Cullen Roche

    Depends what it buys the asset for. Is it really a worthless asset? If the Fed overpays then they are technically printing money. But the Fed is paying market prices so it’s not reasonable to assume that they’re overpaying by much if any. Plus, they’re reducing net interest margin of the banks so I think it all comes out in the wash regardless.

  • Cullen Roche

    You’re furthering the monetization myth. See the link in the article for more on that.

    When the Fed tells the Primary Dealers to sit, they sit. When the fed says fetch they fetch. When the Fed says we’re buying Tsys from you, they sell. The Fed is their master. And they obey obediently.

  • Peter D

    The best explanation I’ve come across of how QE works so far:
    Basically, the Financial Sector adjusts its holding of US treasuries so that in the end the actual holdings of Tsys of the households+firms are almost unchanged! This makes perfect sense to me. All the economic models predicting explosion in money supply following the explosion in monetary base just miss the Financial Secotr. Or, rather, get the Financial Sector totally wrong.

  • Clearly_Irrational

    I wish you were right but housing doesn’t look like it’s bottomed to me, in fact my properties have been losing value again after leveling off briefly a few months back. The housing market can’t truly turn around until the jobs situation improves, though I suppose if we waited long enough population growth from immigration might outpace the currently anemic rate of home building enough to eat up the excess inventory.

  • jt26

    This is a corollary to my question, asked many times about why 30 year Tsys exist. The MMT/TPC answer is they don’t need to exist, but that unfortunately doesn’t satisfy my curiosity (which is ok, as this site doesn’t guarantee me satisfaction or my money back ;->), but also this does lie at the heart of whether Twist works or not.
    – QE, Twist changes duration of the Fed and private sector; one often hears the insurance industry requires duration to match liabilites. Is that true in an MMT paradigm? Does the private sector care that 30 yrs exist?
    – if the Fed twisted away all Tsys > 3 mo, what would happen?

  • Harry

    Cullen, with all due respect to the good stuff you generally produce here, this post demonstrates a rather poor understanding of central bank policy, and credit creation.

    We can quibble a lot on whether QE worked in terms of achieving the micro-objectives the Fed had with it (probably yes) and we can quibble even more on whether it has helped the economy on a macro level (probably not much if at all).

    But what is a lot less disputable is that when the Fed expands its balance sheet on one side, and buys UST en masse on the other, it is printing money in the monetary sense of that expression. And it doesn’t even necessarily matter what they buy or at what price (market or not) – look at how the BoJ does it and what they buy for an example. Yes, sure Ben & Co are not actually going down to the basement and to start up ye olde printing press, and there is no physical cash increase, but the amount of money in circulation (express it in M# if you wish) increases. This is what Friedman was referring to and he certainly didn’t misunderstand it.

    And it is certainly not an asset swap. An asset swap suggests that there is an exchange of two goods that fulfil basic economic principles in terms of tangibility and scarcity. I can swap my apples for your pears. I can swap my cash for a TV set. I can’t swap a TV set for thin air. If I could create cash out of thin air, that’d be nice and get me a lot of stuff, but I can’t. The Fed can. And they do it – by creating liabilities (‘cash’) in -theoretically- unlimited quantities – for better or for worse. They then pump this newly created cash in the system by using it to buy assets, in the recent cases of QE in the US, they bought UST’s – for various reasons that are not at stake here now. For the banks and other sellers of UST’s, the brand new cash becomes an asset added to their short-term liquidity reserves.

    Which brings me to next flaw in your reasoning. Banks don’t lend their reserves? Sure. The moment they would lend reserves, these are not reserves. All sound and logical. But banks lend against their reserves. More reserves means more lending capacity. Doesn’t mean they will use this capacity, but all other things being equal, increasing reserves and hoping that it will trickle down is the best you can do from a Central Bank’s perspective. For anything more, you need fiscal policy help, which is unfortunately for the US not really an option due to what can only be classified as completely dysfunctional legislative branch. But that is another story.

    This is turning into a monster comment, so I am going to shut it here, but to get a better understanding of how QE works (or is supposed to work), I would humbly suggest you look into how banks manage their balance sheet and focus on keywords like maturity matching, required return on capital, curve steepening/flattening, liquidity measures, credit creation, reserve requirements, and how all of these affect lending behaviour and what this generally means for businesses and consumers who are on the other side of that coin.

    Oh, and no – I am not in favour of (more) QE, and as mentioned I don’t think it has done a great deal to help the economy. But it is printing money, it does increase bank balance sheet liquidity and it does bring down the curve and with all that, it changes the dynamics and incentives of bank lending. Sufficiently? No – and that is because QE is at best part of a larger equation which will take a lot of time (years if not decades), and lots of other monetary and fiscal tools to get right.

  • MMTer


    You are the one who is not correct here. Cullen is one of a handful of analysts who actually predicted what QE2 would do before it happened and actually got it right. His analysis is thorough and accurate.

    What Friedman believed was the quantity theory. You are correct that the Fed can expand high powered money as much as they want, but this does not mean they are altering the net financial assets of the private sector. So you’re wrong when you claim that QE is not a swap. The banks trade bonds for reserves. Have they created more capital? Absolutely not.

    This goes right into the other important point that you have dreadfully wrong. Banks are never reserve constrained. They are capital constrained. As QE doesn’t change their capital position, it doesn’t change the lending capacity.

    Cullen has covered all of this in detail here at the site. I don’t have links, but maybe you should poke around some more and figure it out because your myths are the same ones that we see in most articles these days.

  • LVG

    The US government already got rid of the 30 years once. Nothing really change.

    If we got rid of all US Treasuries we’d have to see a massive shift in the way the public saves because their savings income would decline. Would that be good or bad? I don’t really know. I think MMT knows that the bond market doesn’t need to exist, but I think MMTers also know that the bond market will continue to exist. So it’s sort of a moot point, isn’t it?

  • JJ

    Relatively new to this site and work in commercial lending. I would agree with the capital constrained bank lending portion. We certainly do not have a liquidity problem. That said, I would say at the moment it is more a lack of qualified applicants, demand for loans, and increased regulatory (FDIC) constraints that are mostly constraining bank lending. One aspect not often cited is the effectiveness of government guaranteed loan programs. These do produce greater volumes of loans as they remove some typical constraints and effectively expand the pool of qualified applicants. Also not noted is the extent to which many banks have not lowered deposit pricing in keeping with more general falling rates. Presumably, depositors may be more inclined to spend (or invest?), circulate money, if deposit rates were to fall lower. I personally think that would have a miniscule effect.

  • InvestorX

    Milton seems like a pure data miner – saw one data series that fitted as an explanation and decided this is it, ignoring all other possible explanations.

  • InvestorX


    without being MMTer (and thinking in the NFA terms, which are debatable in my view), I can tell you the following:

    The Fed prints reserves, not money if they buy the USTs from banks and not the general public (which is what the Fed does). Reserves are basically idle cash that stays at the banks (and earns now 0.25%) – look at the chart of excess reserves. So no new cash has truly entered the economy.

    Bank lending leads Fed’s reserve creation, so banks have unlimited lending capability, as long as there are no binding capital constraints.

    The only effect of this is psychological / portfolio rebalancing, pushing future expected yields on all assets in investor portfolios lower. We had an overshoot of risk assets, now the correction to reality.

  • InvestorX

    I think in QE1 they overpaid, which was a gift to the banks and thus they entered fiscal policy without permission and authorization.

  • InvestorX

    Wow, very well said!

  • Pepijn

    As i understand it, the helicopter drop is meant to combat declining or negative inflation by increasing the money supply. In that QE has been superbly effective. Despite all financial market turmoil and economic upheaval, the one thing that stands out is that inflation has stayed on target wonderfully well. In other words, QE does work.

    Though it can be debated whether QE is really a good thing in that it created a bifurcated economy whereby the (lower) middle classes suffered even more due to unreasonably high petrol prices given economic slack whereas the rich got even richer thanks to yet again a good dose of FED propelled asset price inflation.

    On target inflation is meant to keep consumption on track and real debt loads under control. However, one must wonder if these positive effects are not cancelled out by households having to spend a far greater proportion of their income on food and energy.

  • Harry

    MMTer. We are probably going to have to agree to disagree, but a couple of points:

    I have no desire to evaluate Cullen’s past prediction record, nor to wade through his prior postings after this first one I happened to read. Let us stick to the point at stake here.

    You are right about the Fed’s expansion not changing the net financial assets of the private sector, but this is besides the point. The point is that bank reserves are part of the monetary base, and UST’s are not. Friedman (or anybody else in ‘most articles these days’) didn’t claim that QE is creating capital, it is creating money. QE was never meant, and can never be, a bank capitalisation scheme (although it has a minor side effect in that direction in terms of the effect on mark-to-market capital). The mere idea of thinking of it in such terms is a fallacy indeed. QE increases liquidity, not solvency, in the sense that it brings value stored in long-term assets, back into more liquid, short-term moneyness.

    You are also right about banks not being reserve constrained, and re-reading my own writing, I can see why you think I suggested that they were. Let me put it this way, and let’s imagine you run a bank out of your garage. Perhaps with a branch in your uncle’s boathouse, I don’t know. Your capital position consists of $100 in 10y UST, which you bought for that amount, and which pays you 5% coupon. One fine morning, a business owner named Terry walks into your garage, I mean bank, and asks for a 1y $100 loan. You spend a couple of days assessing his loan request and figure that for this loan to have the right risk vs reward balance, a reasonable rate of interest to demand would be 4%. Will you give him the loan? No, because you’d be nuts to take your money out of that 10y UST which gives you 5% and give it to this Terry fellow whom you never saw before for only 4%.

    You think this over and decide that therefore, to make this worthwhile, you want Terry to pay 8%. Terry considers this proposal, but decides not to take this loan, since he could imagine using this money well enough to have a ROIC that exceeds 4%, but not 8%.

    Then this fellow called Ben shows up in a helicopter, and offers to buy your 10y 5% UST for $120. You have no idea where get his money from, but this seems like a great deal, since at that price your UST is only yielding 2.7%. And hey, he has a helicopter. So you sell it to him. Now you have $120 in cash, but no yield (we are assuming short-term interest rates are zero). You mull this over a bit and ring up your neighbour, who also runs a bank in his garage and ask him if you could buy his UST to get some yield. Unfortunately, the neighbour also just sold his UST to Ben. Then you remember Terry, and how he was willing to pay 4%, which seemed paltry at the time, but now seems a like a pretty good deal because Ben took your UST away.

    This is QE increasing liquidity, and lending capacity, and I suppose I am using the latter term loosely and arguably not properly. But what I am trying to convey is -again- that the dynamics and incentives of bank lending are changed by what the Fed has done (or will do again). Does it really work to get the economy kick-started? No, for a whole host of reasons, but I stand by the point that QE creates money, increases bank liquidity (yes, not capital), and therefore -let me be careful now- the likelihood that banks will use/increase/grow their lending capacity.

  • InvestorX

    This article by Pavlina is the best summary of the MMT view I have ever seen. It moved me closer to accepting most of it.

    One of the “real world” flaws that remains though is that MMT assumes the system can be run by a “benevolent dictator”. Whereas I see the system as a result of the banking lobby taking over the economy and using the system mainly for its purposes of wealth redistribution towards itself, using public money to cover its blowups, and corrupting and now owning the whole political process.

  • Harry


    We don’t disagree apart from terminology perhaps. If you don’t include reserves in your definition of money, then fine – the Fed is not printing money. When I say ‘money’ in this context, I am talking about the monetary base, and the Fed has increased that.

    And yes, it is being hoarded and not entering the ‘real’ economy. Completely agree, but the effectiveness of the policy is not the topic of this discussion – it is the macro economic, descriptive interpretation of what the policy constitutes.

    See my reply to MMT for a clarification on ‘lending capacity,’ but there too I agree – theoretic lending is unlimited, although of course there definitely are and always will be capital constraints.

  • InvestorX


    then we agree – Fed has printed money (reserves), but this is not inflationary (not now and not in the future), as money creation comes from i) bank lending; ii) fiscal spending. And the former is somewhere near 80-90% of money creation over the last several decades.

  • InvestorX

    “money creation” in the sense how money enters the economy. Money that is created, but never enters the economy is irrelevant.

  • InvestorX

    Hm, your argument that QE increases banks’ liquidity and thus propensity to lend has some merit and is similar to the portfolio rebalancing view. I think one of the MMTer’s counter-arguments would be that USTs and reserves have the same liquidity and fungibility and thus the effect is negligible.

    I would be curious to hear the MMTer’s view on that point.

  • Harry

    Yes, that is indeed a key part of the argument, and by most accounts one of the most important reasons the Fed embarked on QE. As long as the yield curve is upward sloping, liquidity encourages credit activity. Again, all other things being equal… which they unfortunately never are.

    Very well – but let’s not forget the term liquidity is not used here in the sense that Citi is a very liquid stock (ie, high turnover, lots of buyers/sellers, small spread) and, say, a small-cap Mexican corn producer is not a very liquid stock. The market for UST is, depending on which issue etc, fairly deep and liquid. But that is not at stake.

    Liquidity in this context = being in cash or easily convertible to cash. In a zero-interest environment, banks should be looking to put that cash to work, and the Fed has been trying to get them to – by making it very unattractive to be in something like a 10 UST at 2%. Not working, and why is a very interesting discussion that is raging everywhere in the financial and economic press. Recurrent themes: de-leveraging, risk aversion, fiscal uncertainty, etc etc.

  • Cullen Roche

    Right. It creates a portfolio reblancing effect which drives investors to reach for yield and higher risk assets as they look to replace the lost income stream. But this doesn’t mean the Fed is materially altering the pvt sector economy. It’s a lot like claiming that a buyback alters the underlying fundamentals of a corporation. That’s utter nonsense.

  • Cullen Roche

    This comment by Harry also conflates monetary aggregates. It’s like all the people currently staring at M2 saying “whoa, the money supply is exploding”. Except, they’re not looking at the whole picture and the fact that institutional money funds are collapsing, small time deposits are falling, commercial paper is falling, etc. You have to look at the whole picture. Unfortunately, the Fed doesn’t produce M3 any longer so we don’t really know, but looking at a picture of M1 or M2 and concluding that the Fed has “printed money” is very misleading.

  • Cullen Roche

    This chart by Shadow Stats proves my point perfectly. Look at the surge in M1 and M2 in the following chart. Then compare to M3 by SS. No change. Odd, no? Not if you understand the aggregates.

  • Some Guy

    Saw your pic, what are you twelve years old? Do you really want to step to Uncle Milty, kiddo?

  • Peter D

    Harry, if the Fed is paying $120 for a $100 fair market value bond, then it is conducting a fiscal policy, whether it is aware of it or not. The effect is the same as if the govt just spend $20 into the economy and MMT will agree with you that this is effective in boosting aggregate demand.
    But Fed is not paying 20% premium for the bonds its buying. Why would the banks sell the bonds then, you ask? One answer is that the Fed does pay a small premium (but not 20%!). But the real answer I think lies in these two links I already brought in this thread:

  • Cullen Roche

    Ah, the age thing. That’s always a fun retort. So, do you have any facts or do you just shrug off anyone without gray hair as being an idiot? Surely, you have a better response in defense of Uncle Milton, than “you look young that means you’re stupid!”

  • wh10

    Ritholtz is giving this post some ‘love.’ He also linked to your MMT overview several weeks back. I was quite surprised since he has openly and disrespectfully bashed MMT with no substantive economic arguments in the past, though perhaps this was mostly due to pesky and disrespectful commenters. In any case, it’s so frustrating observing the MMT commentary over there; many of those readers have no clue, at least when it comes to MMT.

    Edit: Hey ohhhh! Edit functionality!

  • Cullen Roche

    This data is all public also. For instance, the other day, they reinvested $151MM in a 7 year note with Cusip 912828QG8. They paid an avg price of 108.56. I don’t know what the market price was the on the 19th when they bought it, but today it’s 108.64 so they’re not paying massively in excess of market prices for these bonds if at all. One more (randomly selected from the other day) : 912828QT0. They paid 106.856. Today’s price: 106.89.

    I think that solves this conspiracy theory.

  • wh10


  • Colin, S.Toe

    Ron Susskind’s latest work indicates Obama largely relied on Summers and Geithner to shape economic policies, and is pretty critical.

    Among other things, they kept the women out of the loop (and Baer and Rohmer, who seemed pretty on the ball, both left fairly soon).

    Most astonishingly, he claims Geithner essentially distregarded an Obama directive to take the TBTF banks into receivership.

  • Harry

    No Peter, the Fed indeed doesn’t pay a 20% premium. Let me also state that I also don’t run a bank in my garage, to make sure you understand the difference between reality and a fictional example to illustrate a principle.

    I can only note that most people here have a very original way of using definitions. When the Fed buys a bond at a premium, it conducts a fiscal policy?! Really Peter? Do you even understand what fiscal policy is? Look it up please.

    The common thread in this blog and this comment thread is to stretch definitions and concepts way out of their original scope, or cut them down to a shadow of their original self. And then go back at people like Friedman who used these terms in their proper meaning and say they are wrong/misguided.

    It is a very grand intellectual fallacy that is going on here. ‘The sky is blue.’ ‘No it isn’t, because we just decided that blue is now what other people call green.’ ‘Aha. Yes, then you are right and I am wrong.’

    If you either narrow ‘money’ to ‘money in physical circulation’ (like X did), or you widen ‘money’ to the now-defunct concept of M3 (like CR apparently does), then sure, the Fed didn’t print money.

    You can’t have a decent discussion if you keep shifting your terminology.

    Now the fed buying bonds is a fiscal policy? Why? Because they do it at more than the market price before they started to buy? Do you suggest they try to complete bond purchases below the market price? Sorry but it is really nonsense. The Fed buying/selling bonds is how it conducts most of its business, QE or no QE. It is basic monetary policy. You may agree or disagree with their strategy and I am very happy to have discussions about it, but for crying out loud, stop denying fundamental concepts.

  • Peter D

    Harry, definitions are fine, but it is when you’re trying to poke what’s behind the definitions then you discover how things actually work. Or why they don’t work as expected, like in the case of QE2.
    To understand why there is no difference between fiscal policy and the Fed paying for non-govt assets at a premium, I suggest this reading:
    Helicopter Drops Are FISCAL Operations

  • Peter D

    I am also surprised at the uncalled for huffiness of your post. If you read my comment in full, you’ll see that I understood very well that you were using an example to illustrate a principle. Because I said that the Fed would probably pay a small premium just to make the transaction worthwhile for the counterparty.

  • Harry

    CR, I probably need glasses, or there might have been speed in that Diet Coke I had this morning, but I am seeing that thick blue M3 line (for what it is worth – not much imho) slope up rather steeply from right from about the time QE started.

    I am sure I am just hallucinating, even though it is rather logical because M3 includes M2, which in turn includes M1. And while we are at it, by most estimates, about 70-80% of M3 is made up of what is in M2 and M1.

    So I really have absolutely no idea what you are going on about, nor do I think you understand the ‘aggregates.’

    As mentioned already in this thread, you seem to be mainly messing around with definitions.

  • Harry

    CR – I made it very clear what I mean (and not just me) in this context by liquidity. And it is not what you imply there. At all.

    Secondly, as mentioned to Peter – I am pretty sure as well the Fed is not offering 20% premiums on a daily basis. The point of the ‘conflated’ (I think you mean inflated, but nvm) example was to illustrate the point of bringing down the LT interest rate and what it does to credit lending incentives at banks. I note you ignore this point.

    I can assure you that no party out there will sell a bond to less than the ‘market price’ (no an obvious concept in the bond market, but let’s assume you mean the midpoint price between the outstanding open, ‘hard’ bid and ask on the issue), not to the Fed and not to anybody else. Never mind it is trading lower the next day or a week later. That tells us absolutely nothing.

    If you want to buy a lot of bonds, and especially if you tell everybody about it in advance, you are going to have to pay for it. And that is all fine and dandy, really. In fact, it is part of the point. The fed WANTS to pay more and more for these bonds. For their whole purpose was (is?) to bring down the implied yield on these securities.

  • Harry

    I am not a big Krugman fan, but I am beginning to understand why he is speaking of the ‘Dark Age of Macro-Economics’.

    I am going to have one more stab at it, but think we really reaching the ‘agree to disagree’ point of this discussion, since it all boils down to how you define things and how you use those definitions in an analytical framework. I am of the opinion that definitions should be narrow and unchangeable, and my framework is rigid and conventional. Not always a good thing perhaps, but it does put one on more solid ground to test new hypotheses, where possible empirically.

    Thanks for the link, but unfortunately that article suffers from the same definition problems.

    “We define fiscal policy actions as those which alter the non-government sector’s holdings of net financial assets (net worth in the figures here), since that’s what EVERY fiscal action actually does.” (last paragraph of the post you linked to; a curious place to put your definition in an argument, but there it is).

    Now, one of the interesting points here is that this is 100% against what CR has been clamouring about here (‘QE does not alter the net asset base of the private sector, it is just a swap’ etc), but that aside. This is not a definition I would subscribe to. Mainly because it is way too wide a definition. For example – on a national basis, this would also suggest that any action that involves money flowing in/out of the country is a ‘fiscal policy.’ So signing a trade agreement is a fiscal policy. GE moving its production abroad is a fiscal policy. Failing to stop GE moving its production abroad is a fiscal policy. Failing to stop Americans from going on holidays and spending money abroad is a fiscal policy. Interesting but very slippery slope.

    And actually, this curious definition turns any monetary policy into a fiscal policy. One of the prime objectives and powers of ‘normal’ monetary policy is to manage inflation (and inflation expectations). Which in turn affects long term interest rates (and again, expectations about it). Which in turn has major effects on things like required return on investments, and discount rates when companies value their future cash flows, and both tangible and intangible assets. This is the classic time-value of money story. $100 today is worth more than $100 in 10 years. If I expect inflation to average 2% over 10 years, I would value this $100 at, roughly, $82 today. If the Fed would come out with a monetary policy that shifts my expectation for inflation to, say 3% pa over 10 years, I would have to adjust the book value of my deferred $100 payment to $74. There is a liability effect as well there, but unless assets vs liabilities are in perfect harmony, the monetary policy that spiked inflation expectations just altered ‘the non-government sector’s holdings of net financial assets (net worth in the figures here), since that’s what EVERY fiscal action actually does.’

    Sorry again, but really – if you start twisting your definitions, you can prove anything. Every fiscal policy alters the private sectors net holdings, sure. But that doesn’t make all policies that do this fiscal policies. All birds have wings, but a bat is not a bird.

    There are various definitions of fiscal policy possible, but this is a particularly wide one. Too wide to be useful, unless you want to prove a point about ‘helicopter drops’ and install fear in people that The Evil Fed is about to take over the country and create massive inflation as Ben Bernanke goes after the title of Caesar.

    Fiscal policy in my view is about government expenditure and taxation. It is a budgetary thing. It is about revenue and expenses, a profit and loss account on a going concern basis. It is about decisions to collect more here and/or spend more there. That is very different from a Central Bank balance sheet expansion/contraction, and that fact is compounded by the Central Bank having an unlimited capacity (theoretically) to expand its balance sheet. The government doesn’t. Go and ask the people of Greece how that one works if you don’t believe my word for it.

  • Peter D

    Harry, did not have time to read the whole of your comment, but as a quick note, non-govt sector includes the foreign sector – it is the complimentary sector to the govt sector. So, all of your objections are inapplicable, as far as I can see. More tomorrow.

  • Peter D

    And comparing the govt of Greece – a currency user, to the US govt – a currency issuer, is like a red cloth to us MMTers! Beware! :)

  • Cullen Roche

    It’s near record low growth rates? In fact, M3 is several% points below its avg annual growth despite 2T in QE as Milton would have recommended…..It’s clear that you’re the one trying to alter reality….

  • Cullen Roche

    If you’re truly interested in trying to better understand my points I would recommend reading this piece.

    Thanks Harry.

  • Peter D

    So, to return to your comment, your objection about foreign trade is irrelevant, as foreign sector is part of the non-govt sector. You do have a point that almost any monetary policy would also have a fiscal policy component in that it might change non-govt sector’s net financial assets. I guess the thing to keep in mind is that as long as premiums/discounts involved are small, then the fiscal component of monetary operations is negligible. Another important thing is that monetary policy can be conducted with no transactions by the CB at all, as in “open mouth operations” in which the CB announces the new FFR and the market quickly gravitates towards it on its own. See Marc Lavoie paper on that, for example:
    So, not to miss the point for the definitions, if the CB significantly overpays for non-govt assets – for example, if it purchases junk ABS collateral (like in QE1) that later defaults – then the effect on non-govt sectors assets is the same as if the govt just spent the money into existence. With a caveat about the distribution of this new money in the non-govt sector, of course.

  • Hans

    Has not all of these QEs produced excess bank reserves?

    Are they not loanable?

    Tanks for any helf!

  • Peter D

    Hans, reserves are “loanable” but that doesn’t mean they are going to be loaned. The banking sector cannot force loans on people. If there is no demand for loans from creditworthy customers, then it doesn’t matter how many excess reserves are in the system. On the other hand, even without excess reserves, when demand for loans from creditworthy customers picks up, those reserves will be created in whatever quantities needed. So,the amount of reserves in the system is neither a constraint on nor an enabler of credit expansion, whether healthy or not.
    Given the existing “fractional reserve” system, the reserves are required to maintain the system. It is like blood in your body. The volume of blood will accommodate whatever size your body grows to.