No money should go in through that door!

Yesterday Neil Irwin got some criticism for not mentioning the fact that fiscal retrenchment wasn´t having all the expected contractionary effects on the economy largely because monetary policy was offsetting it.

In fact, he was ‘reasoning from a GDP components change’, which obviously got him nowhere.

Today he answers his critics:

The U.S. economy, as I wrote yesterday, seems to be holding up well despite the onset of fiscal austerity. Jared BernsteinScott Sumner  and Ezra say I should have mentioned an  important reason: the apparent success of the Federal Reserve’s policies, introduced last September, of pumping more money into the economy and pledging to keep rates low even after the economy improves.

They’re right! But that may not be a good thing.

There is good reason to think that monetary easing is doing quite a bit of the work offsetting tighter fiscal policy. The Fed’s policies, including buying $85 billion in bonds each month with newly created money, are directly aimed at housing; $40 billion of those purchases are of mortgage-backed securities, meaning the money is being funneled directly toward the sector. And sure enough, a solidifying housing market is an important part of the economy’s holding up. And a second important consequence of Fed easing is to boost the prices of other financial assets, including the stock market.

This isn’t rocket science: The Fed in September introduced a policy meant to boost housing and stock prices, and now, nine months later, housing prices and stock prices have risen quite a bit. Enough, indeed, to (so far) offset the impact of higher taxes that went into effect Jan. 1 and federal spending cuts that took effect March 1.

So far so good. The bad news, though, is that these channels through which monetary policy affects the economy tend to offer the most direct benefits to those who already have high incomes and high levels of wealth.

No matter that about 65% of households are homeowners and that many believe that ‘housing is the business cycle’.

Mr Irwin disregards all indirect and spillover effects because he´s not comfortable with the ‘door through which money first goes through’!

3 thoughts on “No money should go in through that door!

  1. New post by Paul Krugman:

    “Rate Stories”

    He talks about a story that if the Fed “may be ready to snatch away the punch bowl sooner than previously believed,” then that implies that bond prices should go down.

    That is wrong. If the Fed may be ready to snatch away the punch bowl sooner than previously believed, then that implies that bond prices should go UP. Not down.

    When he writes his posts, Krugman needs to be more clear that when people tell stories like these, they are exactly wrong. They have it backwards.

    After reading Krugman’s post, many people will come away with the mistaken conclusion that tighter Fed money could drive long-term bond prices down. No. The relationship is exactly the opposite. Very unfortunate.

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