Why we are printing $1.2 Trillion (super simple explanation)

[Kurt_and_Hunter]

What makes our current recession uniquely dangerous and difficult is that Fed interest rates were essentially zero before the downturn even got really nasty. The downturn is bigger than interest policy can handle so we used up our interest rate bullets--out of necessity--early in the fight.

The usual Fed response to economic downturn is lowering interest rates.

Had the Fed responded to the hard data in their usual way the Fed funds rate would have been reduced to (-6%) by now.

Unfortunately, we cannot make interest rates negative so 6 points of needed easing has not been possible.

There are ways the Fed can buy the effects of an interest rate cut like printing money and competing in the bond markets to drive up bond prices (when bond prices go up the interest rate return goes down, and visa-versa)

But those other ways of approximating rate cuts are inefficient and expensive. It is estimated that it takes between $1 trillion to $1.6 trillion of "quantitative easing" to approximate the effect of a 1% Fed easing.

So the Fed has had the unhappy task of needing to create and spend $6-10 trillion just to make up the missing 6 points of easing that we needed but couldn't get because rates were already near zero.

So $1.2 trillion isn't that big a deal... it's only a small portion of what's required.

[Jennicut]

1. So was making the rates so low to begin with a bad idea?

Sounds like it.

[Kurt_and_Hunter]

4. That depends on which time frame you're talking about.

The time for the Fed to have raised interest rates was 1997-1998 to knock down the internet bubble. And higher rates in 2004-2005 might have restrained the housing part of the overall asset bubble some.

So yes, interest rates (and inflation) have been too low for a long time.

But the specific moves that took us down to zero were correct. When you face a recession you cut rates because that's the cheapest way to increase growth.

And if things keep getting worse you keep cutting until you run out of room.

Since rate cutting is more efficient than "quantitative easing" it's correct to use that first. Had the Fed kept interest rates high in a potentially deflationary environment we would be facing Great Depression type statistics today so the needed 6% easing would be a needed 10% easing, and so on.

There is a complicated theoretical argument for keeping interest rates higher while printing even more money, but it all works out the same. This is a bad one and one way or another we were going to need every tool in the Fed toolbox and then some.

[dkf]

2. Is the inflationary impact the same then?

Or is this a bad way to do what we could have done had we been able to lower rates?

[Kurt_and_Hunter]

6. The inflation impact will be small.

The folks who are upset about potential inflation are mostly wing-nuts.

The best evidence of inflation is inflation and we are not seeing any.

Bond traders are sophisticated. Bond prices reflect aggregate inflation expectations. There is nothing in bond prices to suggest the serious money people are expecting runaway inflation, and they know exactly how much money we have been printing.

The world lost at least $30 trillion of asset valuation last year. That's a gigantic money hole and shoveling a few trillion into it will not create hyper-inflation.

Will it create some inflation? Only if it works. We need some inflation. Inflation is like the idle speed of our economic engine and the biggest danger we face is inflation dropping too low and stalling the whole machine.

5% inflation would be much, much better than contraction. 500% inflation would be a disaster.

It appears that we are not facing any disaster-inflation scenario.

The people at the Fed are all inflation hawks at heart. (Bigger inflation hawks than me, for sure) 90% of the time fighting inflation is their central mission.

So when they say the biggest threat we face is deflation I take them seriously.

[dkf]

10. I guess what concerns me is the flight to commodities, specifically oil

if there is a fear of inflation.

An increase in oil prices is hard on the average joe.

Is a flight to these types of assets simply a speculative bubble that bursts or is it a legitimate way to preserve value?

[Kurt_and_Hunter]

11. You can have market aberrations in commodities, but not for too long

Some of the bubble money ran into oil for a while but those high prices were not sustainable because people actually use oil -- unlike gold and stocks.

I don't doubt that clever traders can create aberrations in markets but things are down so much right now that unless global industrial production increases any spikes in prices will be impossible to sustain.

At some point physical unused barrels of oil will begin piling up because the world really is using a LOT less oil because of the economic down-turn. (And the producers don't have the luxury of cutting production because their own economies suck.)

[pokercat999]

3. Some of the RW crazies are predicting 20% inflation

(Joe Scarborough). In this case might they have a small bit of fact on their side in that printing large amount of money usually leads to inflation? If they're wrong, why and how is it different for the US? Is 1.2T just too little in our economy to effect inflation and if so how will it have the desired effect on banks?

I really don't understand macro economics but I'm not alone, I don't have any faith in ANY officials of our government when it comes to the economy.

[Kurt_and_Hunter]

8. They are being silly.

The Fed has been printing money like crazy for a year and mortgages are pushing down below 5%. 30 Treasuries are in the 4%s.

If anyone seriously expects 20% inflation they would not be lending money for 30 years at 4-5%.

The market that the wing-nuts trust offers a daily update on inflation expectations and the market says it is smart to lend money at 5%.

Typical. The wing-nuts trust the market like it was God, but only until it contradicts their ideology.

[greguganus]

5. We could save a lot of tax money if the government would just let us print our own money. n/t

[Dreamer Tatum]

7. I'm sorry, but $1.2T is a HUGE deal

The risk of a hyperinflation is pretty serious if that money doesn't get sopped up somehow.

[Kurt_and_Hunter]

9. We lost about $20 trillion is asset valuation last year and $12 trillion household wealth

Every penny the stock market and housing went down was taken directly out of the broadest money supply measure.

That's a very large hole.

$1.2 trillion would be a lot of money in usual times but money has been vanishing at an even greater clip so we are running just to stay even.

This is such a bad situation that all options have defects but American household net worth dropped $12 trillion in 2008... a propound de-flationary force.

(I hadn't noticed before, but the 1.2 trillion happens to be 10% of lost household net worth.)

The wing-nuts are right that current policy would cause inflation if the economy were otherwise healthy. But it ain't.

[Dreamer Tatum]

12. Filling a theoretical hole with actual money has its perils

It's an empirical question. If this doesn't get timed correctly, we could go right past the deflation fix ans stright to hyperinflation.

[soothsayer]

13. what dopey investors want to buy our devalued bonds, to be paid back with worthless money?

[OwnedByFerrets]

14. Only one small point and probably not even worth mentioning....

but, its not being printed. Someone sat at a computer and typed in 1,000,000,000,000 and hit enter. It was created out of thin air. Other than that very minuscule point, nice post.

[TexasObserver]

15. That's essentially accurate.

I'm not troubled by the inflationary aspects. We need inflation to fix a lot of this. Inflation can ease the impact of debt where interest rates cannot.