Has Quantitative Easing's time passed?

In a terrific column in the Guardian, Radhika Desal observes that Quantitative Easing and similar monetary policies' failure to power an economic recovery is clear.  However, so long as the UK and US remain wedded to pursuing QE and similar monetary policies, it stifles debate on the alternatives.

Regular readers know that the specific alternative that is stifled is the Swedish Model for handling a bank solvency led financial crisis.  Under the Swedish Model, banks are required to recognize upfront the losses on the excess debt in the financial system.

This protects the real economy as it avoids the burden of having to service this excess debt using capital that is needed for reinvestment and growth.

This protects the social contract as it avoids having sovereigns issuing new debt to socialize the banks' losses and transferring government revenue that is needed for social programs to service this new debt.

Finally, it paves the way for fiscal stimulus to restart the economy.  Without the losses being realized, fiscal stimulus runs into the economic contraction triggered by placing the burden of the excess debt on the real economy and the result is a Japan-style economic slump.

In reality, QE has served, first and foremost, to socialise the losses of the financial systems of the two countries at the centre of the financial crisis, the US and the UK. 

In contrast to the publicly fought over Troubled Asset Relief Program (TARP), QE contributed far more to achieving that objective and did so without the fuss and melodrama of Treasury secretaries going on bended knee before House speakers to beg its passage.

Some find consolation in the thought that at the very least QE prevented the economies of these two countries from falling into outright depression. 

In reality, two other things accomplished this. 

First, unlike in the 1930s, the "automatic stabilisers" – government spending and transfers – formed a floor beneath which the economy could not fall. Second, there were mild fiscal stimuli. But their end now threatens to send economic activity south again in both economies.

Please re-read the highlighted text as this is what your humble blogger has been saying since the beginning of the financial crisis that the policymakers, like FDR, who experienced the Great Depression put in place a system designed to prevent a repeat.

Indeed, insofar as QE was part of a wider set of policy choices that focused on relieving financial institutions of their irresponsibly extended loans but not the households and firms, QE ensured that a highly leveraged private sector would be unable to borrow, whether to invest or consume. 

It would also ensure that the resulting demand conditions would deter even the comparatively unleveraged from borrowing to invest. 

QE is in fact part of a wider policy choice known as the Japanese Model for handling a bank solvency led financial crisis.  Under the Japanese Model, bank book capital levels and banker bonuses are protected at all costs.  As a result, policies like bailouts, zero interest rates and QE are adopted.

Again, please re-read the highlighted text as it nicely summarizes the argument that your humble blogger has been making about why the Japanese Model always fails.

So we shouldn't assume that QE will power a recovery. It probably won't. As Keynes pointed out, under certain conditions (such as those today: rock-bottom interest rates, poor demand outlook, heavily leveraged firms and households) credit easing would amount to little more than "pushing on a string".

Actually, Keynes is wrong that it would amount to little more than "pushing on a string".

Policies like QE are actually harmful as they let the banks off the hook and push the real economy into a Japan-style economic slump.

So why are Bernanke and Carney seeking to tie recovery even tighter to monetary policy with their innovations in QE precisely when its failure to power recovery is clearer than ever? 

It's because without some action on their part, public discussion is bound to turn towards the alternative: a vigorously expansionary fiscal policy, with massively increased state investment in the economy....

Please note, that I agree that expansionary fiscal policy is needed.  However, what is needed first is that the banks absorb all the losses on the excess debt in the financial system.

Without the banks absorbing the losses, the Obama Administration has already shown with almost $1 trillion in expansionary fiscal policy that the drag caused by the excess debt is easily able to offset the benefits of the expansionary fiscal policy.

This point was not lost on the FDR Administration in its day.  Regular readers know that FDR had the banks recognize the losses (recall the bank holiday where a sizably smaller number of banks reopened) before pursuing expansionary fiscal policies.  This combination worked.

In effect the public in both these countries is being told that they cannot get recovery unless the banks give it to them. 

And keeping recovery hostage to the financial system is tied up with something very fundamental.

The fundament as laid out by people like Jeff Connaughton and Matt Stoller is that the politicians do what the bankers want in the hopes that they too will receive a payoff that makes them a part-time senior advisor to a bank for $2.5 million per year.