Quantitative Easing vs. AIG Bonuses

With everyone getting all worked up over a trivial issue, the AIG bonuses, what has gone mostly un-noticed by the chattering class, is that the Fed is going to implement quantitative easing.

What does that mean? Well here is a nice introduction (via Greg Mankiw).

Basically the Fed is going to add more money to its version of a checking account and use that money to buy up various assets. As this happens the price of the asset will rise and the interest rate fall. This, in theory, would make it cheaper to take out loans and thus allow for more money to go out into the economy and stimulate demand. However, there are serious problems with this which is why most central banks don’t use this tool. First, the central bank can lose money on the assets it buys thus leaving taxpayers on the hook. Second it could create too much inflation and even hyper-inflation. Third it can be seen as an indicator of how desperate things have gotten so it could have precisely the opposite effect that is intended.

This is actually a larger issue, in my view, than the chump change surrounding the AIG bonuses.

FILED UNDER: Economics and Business, Government, , , , , ,
Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.

Comments

  1. Triumph says:

    What does that mean?

    It basically means putting more cash into circulation–you gotta watch out for inflation with this activity.

    People have been talking about this for weeks.

  2. Drew says:

    Steve –

    re: AIG triviality…amen

    Now.

    Is there a way to quantitatively evaluate the inflationary impact of printing money now, er, “quantitative easing,” vs the deflationary conditions of the current economy (like lower velocity or asset deflation) and, if so, is the inflationary impact just kicked down the road 2 or 3 years??

    Thanks

  3. odograph says:

    It was big on the blogs I read this morning (Calculated Risk, Barry Ritholtz, Marginal Revolution, Econbrowser, Naked Capitalism).

    I don’t think any of them knows where this is going.

    But my big question is “why now?”

    Weren’t things supposed to be on the mend? This seems kind of like “break glass in case of fire” and at an odd time.

  4. odograph says:

    Drew, I think that the non-trivial aspect of AIG should not be forgotten:

    One of the reasons this is so outrageous is that the promise of such bonuses was in fact one of the very factors that caused our current problems, creating incentives for managers of AIG to get out of solid insurance underwriting and into hedge fund gambling. If anyone had supposed that AIG had “learned its lesson”, this report seemed to dash that hope against the wall like a plate of china.

  5. Steve Plunk says:

    Odo’s break the glass at an odd time comment is very appropriate. This seems like a panic move when we need anything but panic. The markets are rebounding nicely and with a little help with solid policy initiatives we could see a large confidence boost. Policy initiatives that would be less leftist than we have been seeing please.

    I find it very disconcerting how many people disagree with these moves. It’s like Washington is choosing all the wrong moves at the wrong times. Why? Are they all that incompetent? Are they all not listening to the experts? Have they all forgotten the lesson of history?

    Maybe inflation or hyperinflation is their way out of this mess and a big enough crisis they can’t let it go to waste.

  6. odograph says:

    I did think the unemployment chart here had a lot of “virt.” To my eye spikes have had pretty fast reversals, but the straight-up part is usually building the base, not the peak.

    … maybe that is too much “charting the market” to be a real concern, but in terms of publicly available data, that’s the worst I’ve seen of late.

  7. Steve Verdon says:

    I’d like to see that graph normalized by population as well as the number of people in the labor market. Both are probably larger than they were in 1981 and 1982.

  8. Drew says:

    odo –

    You are commenting on ancient history. And I do not necessarily disagree with your observatuion.

    But the current bonuses are directed at a specific and current goal.

  9. odograph says:

    Well, there are a lot of ways to “blow up.” The people we call culprits in this last crash blew up one way. It’s a little bit of a question whether the “blameless” just hadn’t blown up yet.

    For anyone who hasn’t heard, it works like this: Imagine a bet that earns 20% and pays off 90% of the time. In the 10% case, the bet loses 100%. Some of us might take that bet, for small money, but we probably wouldn’t borrow at 30:1 using all we own, to make a monster bet … one that will pay off well if we win, but could leave us owing about 30 times what we were worth before we started.

    But, imagine the bet is complicated enough not to be that obvious, and imagine you aren’t betting your own money. Imagine that you get a monster bonus every year the bet works … and if it fails you only get fired …

    That’s what the Countrywide-style banks did with mortgages and what AIG did with credit default swaps.

    There have got to be more out there … the “plan” works with any number of underlying investments …

  10. Adriane says:

    I hate to rain on people’s parade, but managers have been getting bonuses from promising what engineers could never deliver for many moons now.

    And amazingly, it is always the engineers’ fault and never the managers.

  11. […] at OTB, Steve Verdon notes that the Fed is going to engage in the policy of quantitative […]

  12. Steve Verdon says:

    But, imagine the bet is complicated enough not to be that obvious, and imagine you aren’t betting your own money. Imagine that you get a monster bonus every year the bet works … and if it fails you only get fired …

    And if it goes south there will be a bailout on top of it. You forgot that part. That is what makes it looting vs. simple moral hazard.

  13. odograph says:

    And if it goes south there will be a bailout on top of it. You forgot that part.

    If that’s the only error I made in my slap-dash example, I feel pretty good.