Federal Reserve Bank of Dallas | Ultra Easy Monetary Policy and the Law of Unintended Consequences

The Market Ticker – The Can Is Full Of Cement

Apparently The Dallas Fed, which has been a strong opponent of “QE” in all forms, has come out with a working paper, the soon-to-be-infamous “#126”.

The paper, entitled “Ultra Easy Monetary Policy and The Law Of Unintended Consequences“, is a must-read. It is an excoriation of the “QE more, faster, and evermore” game that has been played up until now as a means of “addressing” problems with our economy.

Among the points made are that:

One reason for believing this is that monetary stimulus, operating through traditional (“flow”) channels, might now be less effective in stimulating aggregate demand than previously. Further, cumulative (“stock”) effects provide negative feedback mechanisms that over time also weaken both supply and demand. It is also the case that ultra easy monetary policies can eventually threaten the health of financial institutions and the functioning of financial markets, threaten the “independence” of central banks, and can encourage imprudent behavior on the part of governments. None of these unintended consequences is desirable. Since monetary policy is not “a free lunch”, governments must therefore use much more vigorously the policy levers they still control to support strong, sustainable and balanced growth at the global level.


I have often written on some of the cumulative (“stock”) effects of QE, with one of them being the devastation that is laid upon capital formation. Capital formation is inherently always tied back to savings, which is discouraged to the point of extinction under “ultra easy” policy; when negative real rates are the outcome for any “safe” savings of funds there is an effective hard bar placed that blocks capital formation from occurring.

The over-reliance on credit thus drives greater and greater levels of speculation “somewhere” in a puerile attempt to maintain the ability to obtain some sort of positive return. But speculation is a zero-sum game at best, and due to slippage and costs is a negative-sum game on balance. That is, for everyone who speculates and wins someone almost invariably speculates and loses more than was won. While the winners become wealthier, everyone else becomes poorer and in aggregate the result is a net loss.

One of the key points made in the paper, and which I have often expounded on myself, is this:

There is, however, an alternative perspective that focuses on how such policies can also lead to unintended consequences over longer time periods. This strand of thought also goes back to the pre War period, when many business cycle theorists focused on the cumulative effects of bank]created]credit on the supply side of the economy. In particular, the Austrian school of thought, spearheaded by von Mises and Hayek, warned that credit driven expansions would eventually lead to a costly misallocation of real resources (“malinvestments”) that would end in crisis. Based on his experience during the Japanese crisis of the 1990’s, Koo (2003) pointed out that an overhang of corporate investment and corporate debt could also lead to the same result (a “balance sheet recession”).

Researchers at the Bank for International Settlements have suggested that a much broader spectrum of credit driven “imbalances”, financial as well as real, could potentially lead to boom]bust processes that might threaten both price stability and financial stability. This BIS way of thinking about economic and financial crises, treating them as systemic breakdowns that could be triggered anywhere in an overstretched system, also has much in common with insights provided by interdisciplinary work on complex adaptive systems. This work indicates that such systems, built up as a result of cumulative processes, can have highly unpredictable dynamics and can demonstrate significant non linearities. The insights of George Soros, reflecting decades of active market participation, are of a similar nature.

This is well-worth the time to read. Being 45 pages it is happily free of ipso-facto mathematical expressions that aver to describe an economic theory (but sadly, lacking proof of predicates claimed, which often devolves upon any sort of critical examination to the economic equivalent of attempting to divide by zero.)

One of the most-startling assertions raised is one that I have often raised in The Market Ticker (and been attacked for asserting), which is that:

In Section C, it is further contended that cumulative (“stock”) effects provide negative feedback mechanisms that also weaken growth over time. Assets purchased with created credit, both real and financial assets, eventually yield returns that are inadequate to service the debts associated with their purchase. In the face of such “stock” effects, stimulative policies that have worked in the past eventually lose their effectiveness.

In other words “created credit”, that is unbacked credit, is a Ponzi scheme as it relies on ever-increasing exponential amounts of credit creation. This must eventually fail to produce sufficient return to service the debt so-created and when it does the consequence is mass-bankruptcy.

Note the applicability of this to virtually everything government and the private credit-creating cartel does. It also applies directly against the current political class and candidates, in that even the so-called Libertarian Gary Johnson refuses to come out for a “One Dollar of Capital” standard, cutting off such nonsense at the root. Indeed, when I raised such a question at the Orlando Libertarian Convention in his suite he brushed aside the suggestion with a comment that it would inhibit economic growth.

Well, Gary, here’s a nice scholarly paper to back up my assertion (which is quite-easily proved if you take the time to think it through and use your $5 calculator from WalMart) that ever-increasing amounts of credit creation are required to keep the system from collapsing once this path is embarked upon, and permanent exponential growth is by definition mathematically impossible.

Spend the time on this one folks — it’s worth it.

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Copy of the paper below…




Ultra Easy Monetary Policy and the Law of Unintended Consequences

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