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03 November 2011 @ 10:46 am
A possible reason that quantitative easing isn't very inflationary  
I was thinking about MF Global's odd (and unfortunate) repo-to-maturity trade, and concluded that one of the developments is that government bonds are effectively money.

In the not-so-distant past, large banks loaned each other money as loans, but the current trend is to post high-grade bonds as collateral. More formally, it's a sale with an associated repurchase, which mostly works out as a loan, but is much simpler in bankruptcy.

So, in practice, financial entities (banks and so on) can get money for these bonds very easily. So easily, that they effectively are money. (Except when they suddenly aren't, as in Greek bonds.)

In such an environment, a central bank can't effectively increase the money supply by buying government bonds, because as a first approximation, they're just trading money for money. The inflationary effects now mostly happen when the money is borrowed, not when the central bankers buy the debt.
Beth Leonardbeth_leonard on November 4th, 2011 01:57 am (UTC)
"The inflationary effects now mostly happen when the money is borrowed"

Borrowed as in deficit-spent?

jon_leonardjon_leonard on November 4th, 2011 05:49 am (UTC)
Yes, exactly.
(Deleted comment)
(Anonymous) on November 6th, 2011 01:10 pm (UTC)
I could be wrong but it looks like government bonds (when used in repos) do indeed just fall under, at least, the "M3" measure of the money supply


I guess one could think that even if the gov't can't increase the money supply buying gov't bonds, they can still affect the yield curve ("Operation Twist"), though I don't really know what that has accomplished or is supposed to.

I think that the serious QE proposals don't involve the government just buying Treasuries though. I think they're supposed to buy up RMBS/ABS and other such securities. I am as skeptical of what this will accomplish as I am of anything else that has been tried, although I must admit I can't think of a reason that it's any *dumber*...

-chris cameron
jon_leonardjon_leonard on November 7th, 2011 05:05 am (UTC)
In that framework, I'm saying something like, "M3 now behaves the way M2 used to." (Though if I understand the definitions correctly, Treasuries not involved in Repo agreements don't count in M3.)