‘QE is an asset swap’ isn’t an objection to anything
So, this is a theme we have been hearing a lot from the MMT (Modern Monetary Theorist) crowd and when I heard it over dinner last night from someone who is not in that camp, I felt that now more than ever that this was an argument in need of clear, simple and decisive refutation. When people say quantitative easing is just an ‘asset swap’, they’re claiming that exchanging bonds for money won’t affect prices. It is true that it won’t necessarily cause inflation, but for reasons that having nothing to do with it being an asset swap. Here is my simple reductio example:
1) Conventional monetary policy operations work via swapping reserves for short-term government bonds
2) If the Fed/BOE/ECB decided to increase interest rates to 10% tomorrow and achieved this through conventional policy, there would be serious deflation
3) Therefore, the fact that anything is an ‘asset swap’ is irrelevant
The reason quantitative easing hasn’t been inflationary in Japan or the US or the UK is because of the expectation that as soon as prices start increasing, the central bank will vacuum up the money again. Temporary injections of money do not affect aggregate demand*^, and it is a necessary ingredient that we must believe the central bank will allow inflation or NGDP growth in order for it to happen.
*Announcements of QE do seem to have had some very modest affects in the US, which is the result of people’s expectations about the Fed’s implicit target changing. You’d at least be more likely to think that Bernanke is determined to prevent deflation
^Thought experiment: imagine the Fed said they will double the money supply tomorrow, and then reduce it to half its current level by 2014. Would you buy a house?