Some unpleasant Quantitative Easing Arithmetic

Some 30 years ago Thomas Sargent and Neil Wallace published an article [1] that raised the possibility of tight monetary policy leading to inflation. Salvatore Rossi and I showed that this result was due to a questionably formulated public budget constraint in their model [2] and basically salvaged the traditional result that it is loose monetary policy that leads to inflation.

The link between that old story and Quantitative Easing is that there is something unpleasant about Quantitative Easing arithmetic, at least for those market observers that, with some justification, interpret recent ECB message as pre-announcement of some exercise of this sort.

…and what about the other side of the pond?

While on this side of the Atlantic the ECB was reacting more quickly than expected to the much weaker inflation prospects, I was in the US trying to better understand what is happening over there in the monetary area.

On the basis of the talks I had, I came back with a number of thoughts, which were not necessarily shared by my interlocutors but were stimulated by the discussions I had with them.

Feydeau, Bernanke and Draghi

Georges Feydeau was a master in his theatre pieces to make actors enter and exit doors, as in a ballet, causing great laughter in the audience.

Also Bernanke and Draghi are busy with exits, albeit in opposite directions and causing much less laughter.

Bernanke started communicating to the market that it should not expect the FED to always ease further and that before too long it should slow down and eventually exit from adding to its portfolio of securities.