Halting QE = Active Monetary Asphyxiation?

A Guest Post By Benjamin Cole

The recent historical and empirical record strongly suggests central bank quantitative easing (QE) works.

The Bank of Japan ran a QE program (the buying of assets, usually bonds, by a central bank) from 2002-2006, coincident with their only sustained economic expansion since 1992. And, of course, the Japan economy is growing again, concurrent to the BoJ’s moderately aggressive QE program, part of the Abenomics package.

BTW, famed Stanford economist John Taylor authored a paper in 2007 gushing about the success of the 2002-6 BoJ QE program—and such a QE program was heartily advocated by iconic economist Milton Friedman in 1998.

Also, the U.S. economy has grown in stutter step to the Federal Reserve’s stop-and-go QE programs as well, even as federal fiscal deficits contracted sharply.

The Riddle Reframed

The riddle is whether both the Japan and U.S. economies will slip into stagnation again without QE, as long as there is a global glut of capital holding down interest rates, and inflation is dead—or even if inflation is near 2 percent on the PCE deflator, the putative Fed target.

The riddle might even be reframed: When central banks do not conduct QE, are they actively engaged in monetary asphyxiation?

Capital Gluts

As posted recently in this space, consulting firm Bain & Co. has forecast chronic global tsunamis of capital for years ahead, pushing interest rates down.

What happens if a central bank targets a 1 percent to 2 percent rate of inflation, when money markets are flooded?

Of course, interest rates cannot drop below zero, even when they “should.” A 1 percent to 2 percent inflation target may result in a central bank that effectively asphyxiates the economy, with resultant interest rates in the same or lower ballpark—but rates not yet low enough to stimulate growth, nor dissuade savings.

The resulting weak aggregate demand neither sops up the excess capital, nor results in higher interest rates or inflation. Call it “perma-zero-lower-bound (ZLB)-stagnation”.

Is that not a picture of Japan through much of recent history, or of the U.S., of late?


With global capital markets glutted, and ZLB ever knocking on the door, perhaps central banks should regard QE as a permanent policy, or at least very long-term, thought of in years rather than months—and after all, the BoJ stuck with the 2002-2006 QE program for four years successfully, and the record suggests the BoJ simply should have kept QE going.

Interestingly enough, even University of Chicago scholar John Cochrane now says converting the national debt into excess bank reserves will not be inflationary, as long as interest is paid on those reserves. He even says the Fed can pay those reserves by printing up more reserves. Call that a “get-out-of-debt-jail-free” card, a welcome fillip for taxpayers.

A Brave New (Capital-Glutted) World

The Fed and other central banks have stepped into a new world order of chronic capital gluts and consequent low interest rates. The traditional central bank tool for stimulus—lower interest rates—is as useful as a firehose against a flood.

Oddly enough, one can wonder if central banks can even raise interest rates—with so much capital afloat, long-term rates may hardly budge. A determined central bank raising short-term rates higher and higher will, ironically, ultimately obtain lower interest rates—recessions and weak growth do not make interest rates go up. And as Milton Friedman famously noted, low interest rates are a sign of tight money. A central bank cannot tighten its way to higher rates in the long-term. In a capital-glutted world, a central bank  will only lower rates closer to zero.

QE may be the only real tool central banks have. (Supply-side tax cuts are a good idea too, but that is whole ‘nother universe).

Inflation Dead

Happily enough, the abundance of capital radically mitigates any bottlenecks or supply-side restrictions that may result in higher prices. Capital is attracted to any market in which prices surge. Indeed, it is folly for central banks to concern themselves with commodities inflation—without such inflation, new supplies of commodities cannot open up.

Consider the recent explosion of U.S. oil production in the wake of higher oil prices. Global oil markets are a study in grievous structural impediments, but higher prices have done what they always do (at least in free markets). In commodities markets, higher prices compel supply growth.

Going Forward

Rather than genuflect to the encrusted bromides and doctrines of yesteryear, central bankers today must consider what is at hand. Interest rates may be near ZLB for the duration, and the duration may run in decades.

Capital is cheap, abundant and hungry, and new businesses and supply will open up if there is demand.

The only monetary channel left to boost demand is QE. Weak aggregate demand has been the recurring bane of Western economies for the last 10 years or more, not too-high inflation.

Moreover, QE has no track record of leading to much-higher inflation, although it is associated with better economic growth. QE does have a side-benefit of reducing outstanding national debt, if directed toward government gilts.

Yet again, it appears a Market Monetarist approach—that is, targeting robust increases in nominal GDP—is the best policy for central banks. And QE is the best, and perhaps only tool to get there.

6 thoughts on “Halting QE = Active Monetary Asphyxiation?

  1. Benjamin, nice post. A few thoughts:

    1. Though out of fashion, a few CBs out there (the US included) still have a reserve requirement in their tool box. Thus excess reserves can be made to disappear overnight by raising the reserve requirement sufficiently (maybe to 170% in the US?). Why do I bring this up? If there were a sudden legitimate worry about out of control inflation, or a need to truly raise interest rates, that would be one (perhaps crude) way of getting there. Also, David Andolfatto has a recent post you might be interested in:


    2. Your final paragraph: I’m not sure QE is the only tool. What about Miles Kimball’s idea of allowing the CB to set a redemption fee on currency? He claims this is one means of eliminating the ZLB (when needed).

    3. There’s at least one model out there (totally different from anything else AFAIK), which I think has some success in explaining the evidence around us in terms of CBs’ power to manipulate the price level. Why does Canada not seem to have a problem, while the US and Japan do? This model also predicts that Sweden’s CB should have little trouble hitting an inflation target (making their recent deflation all the more tragic) while Switzerland’s CB might have problems. It also works for different time periods (the US of the 1970s was in a different circumstance that the US today). The model could be completely wrong, but so far I think it’s interesting, and best of all it doesn’t rely on microfoundations or models of expectations or representative agents or Chuck Norris, yet it is a theoretical model (so it’s not just regression studies… though there are a small number of parameters that need to be fit to the data). Check it out for yourself and see what you think:


    The price level equation at the top there reduces to the QTM when kappa = 1/2. In contrast, when kappa = 1, then the price level is insensitive to changes in M. The kappa parameter itself (the information transfer index) is time varying, but generally slowly so. Also, the equation listed is the “endogenous” solution to the differential equation (DE) resulting from the information transfer model. There’s also an “exogenous” solution that can result in accelerating or even hyperinflation depending on whether or not the information sources and destinations are “constant” or “floating”…


    He puts it like this (for the “exogenous” solution to the DE):

    “the monetary base represents a constant information destination that isn’t determined by signals from the aggregate demand (as opposed to a floating information source, i.e. a market determined one)”

    Caution: “endogenous” and “exogenous” are used somewhat differently than you’re used to (floating and constant are touched on here too):


    One of the nice things about his posts (whether or not his model ultimately proved to be correct) is that he’s taught me to be cautious of disguised circular reasoning that can often creep into these discussions. For example:


    Similarly, I might have a model of CB jenesaisquoishness. What is CB jenesaisquoishness? By definition, it’s that property of CBs, which in conjunction with adequate OMOs allow them to hit their inflation, price level, or NGDP level targets. If a CB looks like it’s doing enough with OMOs but still not hitting their targets, then by definition their jenesaisquoishness is insufficient. Those who ask what specifically needs to be done to guarantee sufficient jenesaisquoishness are known as “the people of the concrete steppes.”

    • Tom Brown:

      1. In the unlikely event of too-high inflation (say above 5-6 percent) the Fed can, as you say, raise reserve requirements, or, of course, pay higher IOER (I forgot about this too). What John Cochrane says is that the Fed can pay higher IOER simply by printing money–so the taxpayer is off the hook.

      2. Kimball’s idea is theoretically fascinating. I just wonder if it is practical. QE is already here and done–so we know it can happen. It even seems to work. So, why not more QE?

      3. This may be over my head. I need to spend a lot of time to figure out these models.

      As I say, I am leaning to aggressive use of QE, and, if necessary, twinned with tax cuts on the middle-class. I suspect real interest rates should be negative now, but they cannot go below zero. And that CBs think they are being “loose” when rates are low (nominally), but actually CB’s should be shooting for negative rates. They can’t, so they need to do QE.

      • Benjamin, thanks for your response. It took me some time to get my head around some of Jason’s ideas, and I’m still not there on everything. He frequently starts a new line of thinking that I can’t follow, but the basics of how the price level can be seen as detecting the information flow from demand to supply is covered in a couple of his easier to understand posts (in which he also derives some fundamental differential equations and their solutions). Again, I love the concept since you don’t need models of utility maximization or rational expectations, etc: you could say he takes the “maximum ignorance” approach with regard to human scheming, strategizing and expectations, much like a 19th century physicist had almost no clue what a molecule was, and had no hope of modeling their individual vibrations and movements in a container of gas (containing astronomical numbers of molecules), but nonetheless was still able to come up with a successful “macro” scale ideal gas law (with a tiny number of parameters) and a theoretical justification for them using statistical mechanics. By that point in history the concept of “phlogiston” had been completely discredited… an idea that Jason likens to how “expectations” is sometimes used to facilitate circular reasoning today. Here’s one of his posts on the basics of his approach:


  2. I would caution that there was lots of QE in the 1930’s too without much to show for it; and so there needs to be something else to get demand for everything including credit moving where it should. I’d suggest something like getting Plosser and Weidmann to “stuff socks in it” as a first step, then ditching that infernal IT/interest rate peg regime for at least Hetzel’s TIPS target for some Rooseveltian resolve.

  3. Dajeeps–

    1. Clue me in on 1930s QE. What happened?

    2. I have speculated that QE should be married to serious tax cuts on the middle class….for that matter, I would even be open to eliminating FICA taxes and financing contributions through QE, or money-printing….

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