In a new post, Marcs Nunes has an excellent analysis from a Market Monetarist perspective of an article written by Lars Svensson regarding the effect of the differences between nominal and real values of existing debt during deflation and disinflation. It’s one of those posts that I’d put on my recommended reading list (if I had one), probably at the top.
One of the Svensson quotes presented is this one which contains the best definition of sadomonetarism I’ve seen:
A dangerous thing concerning debt is what Irving Fisher (1933) called ”debt deflation.” It is usually described as deflation causing the real value of nominal debt to increase. Loan-to-value and loan-to-income ratios also increase, since the debt is fixed in nominal terms but the nominal value of assets and income fall. This may hurt the economy through bankruptcies, deleveraging, and fire sales.
But the important thing with the concept of “debt deflation” is not deflation, that is, negative inflation. The important thing is that the price level becomes lower than previously anticipated.
This implies that real debt and loan-to-value and loan-to-income ratios become higher than anticipated and planned for. Everyone has probably not realised that this is something that the Riksbankhas caused with its “leaning against the wind” policy, by neglecting the objective of price stability and conducting a monetary policy that has resulted in inflation below target.
Of course, I am sure it is happenstance that he mentions the Riksbank by name because the Riksbank is not the only central bank with this policy or one very similar. In fact, most major central banks have some variation of the same policy and are equally guilty of leaning against the wind, satisfied with inflation rates that are much lower than target and are even happier the more inflation varies to the downside from the target.
To me, Lars isn’t describing an inappropriate policy, but a weapon.
To change the subject just a little, some might look at the situation here in the US with the Fed noting that we have QE-finity and it isn’t doing much. But I think the problem isn’t in the mechanics. It’s in the tug-o-war that is happening within the Fed between those who think mechanics matter more than what people think. Some things are the way they are because people believe they are, not because they are. And we have lots of muddled, mixed messages about what the Fed wants or how it is likely to behave going forward, in addition to the public statements made about unfounded fears. Fear and uncertainty emanate from the FOMC like very thick haze; and it’s really no wonder everyone else is still afraid – the kind of fear one would feel if seated next to a little kid playing with a rocket launcher (and the kid is the FOMC).
In his February testimony, Bernanke stated that the most likely option for unwinding the Fed’s balance sheet would be to allow the holdings to mature. I picked up on this, but either I was the only one to think it was an important nugget of information or he wasn’t believed. Considering that the Fed has been buying long term bonds with QE 2 & 3, 30 years, and operation twist exchanged short maturity securities for long, if these are allowed to mature as a means of unwinding it means the temporary nature of the totality of ‘monetary stimulus’ or base expansion is long term. It is so long that I may not even be around when it is slowly removed. It was not all the kind of announcement about doubling the base from the BoJ earlier in the year, but it is probably the closest we’re ever going to get.
It seems pretty clear QE isn’t taking us very far because Bernanke cannot do it alone.