This PPT by Paul Kasriel, Chief Economist of Northern Trust Corporation is buzzing on the web ( WSJ Blog, MR etc).
He says if Friedman was alive he would have favored more QE which then leads to credit creation and recovery from the current crisis. People say QE by Fed is Treason, by the measure would we call Friedman a traitor?
His central idea is that growth in credit is what would lead to recovery from the crisis. Credit growth is still very weak and hence we continue to struggle.
Why more QE? He says QE creates credit out of thin air. When credit is created that way, people can buy things without anyone else having to cut its spending.
- When the Federal Reserve purchases a security in the open market, the Fed pays for that security by crediting the security seller’s bank account by the dollar amount of the transaction.
- Where did the Fed get the funds to pay the seller of the securities? It created these funds “out of thin air.”
- Not only does the seller of these securities now have higher deposits, but the depository institution system also has more cash reserves.
- Under normal circumstances, the depository institution system, not a depository institution by itself, is able to create “out of thin air” additional credit by some multiple of the amount of credit created by the Fed under our fractional reserve accounting system for depository institutions.
- However, under the abnormal conditions of capital adequacy concerns, the banking system does not create any new credit above what the Federal Reserve created.
He says instead of Fed targeting a specified quantity of QE to be completed in specific time, it should do QE till a certain growth rate of credit is not reached:
- Because the essence of quantitative easing is for the Federal Reserve to create the credit that depository institutions would otherwise be creating under normal circumstances, rather than specifying ahead of time the amount of securities it would purchase, the Federal Reserve should purchase an amount of securities such that combined Federal Reserve and depository institution credit grow at some specified target rate, perhaps consistent with some desired rate of growth in nominal domestic demand.
- By targeting a growth rate in combined Federal Reserve and depository institution credit, the Federal Reserve would have the added benefit of guidance with regard to its “exit” strategy.
- As depository institutions become able to create more credit, the Federal Reserve would begin to scale back its purchases or engage in sales of securities so as to not exceed its target growth rate of combined Federal Reserve and depository institution credit.
