The discussion of asset inflation and the failure to get money into the hands of real people takes on an ever more urgent conversation since Donald Trump has been elected president. The Trump Shock may be real. And if and when The Donald should stimulate the economy is a real issue as well, as we can see later in this article. But we have to know why asset purchasing by the Fed did little for main street.
George Selgin has discussed the problem of asset purchases on the CATO Alt-M blog. He essentially agrees with Frances Coppola, that asset purchases have not caused a broad prosperity as they should have. He gives a detailed explanation as to the reason for this. It all revolves around interest on reserves. He said:
As for interest on reserves, although it failed to establish an above-zero “lower bound†on the effective federal funds rate, as Fed officials originally hoped it would, the policy did succeed, in combination with the ongoing decline in market rates, in getting banks to hoard reserves instead of swapping them for interest-earning assets. The IOER rate has, for most of its existence, exceeded yields on most Treasury securities, allowing foreign banks in particular to profit by arbitraging the difference between the two rates, and making a general preference for reserves over Treasuries as means for meeting new regulatory liquidity needs a no-brainer. For these and other reasons, the Fed’s unprecedented asset purchases, which might ordinarily have been expected to result in roughly proportional increases in broad money, spending, inflation, and nominal interest rates, affected those variables only modestly, if at all, and did so for the most part by limiting their tendency to decline, rather than by raising them in an absolute sense.
Of course, Coppola would say the pushing M, base money, up through asset purchases, mainly sovereign bond purchases, does not impact broad money much anyway.
Selgin tells us not to forget that:
…rates originally crashed, not because monetary policy was too easy, but because it was too tight. The Fed erred, in other words, not by pushing rates down but by trying to prop them up in the months leading to Lehman’s collapse. Wicksell’s theory is once again relevant. Just as that theory holds that, in order to keep interest rates below their natural levels, a central bank must resort to ever more aggressive monetary expansion, it also implies that a central banks that strives to maintain an excessively high rate target will, by over-tightening, cause spending (or, if you prefer, aggregate demand) to decline. That decline will in turn place downward pressure on market rates, by reducing the nominal demand for funds. The pressure then inspires further tightening, and so on, until the central bank finally relents. The Fed’s efforts to keep rates from approaching the dreaded zero lower bound thus ended up backfiring. Like Oedipus, it appeared fated to achieve the very outcome it desperately wanted to avoid.
