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Peng: Fed Tapering to What?

Except for a couple of technical details:

  1. Central bank can easily control liquidity, but cannot control access to it, as shown by five years of relentless Fed QE. Structural deficiency in demand is insensitive to interest rates. It does not respond to declining interest rate unless it goes negative. As a result, liquidity channels are clogged. Lots of borrowed money is piled on at the top segments of the liquidity chain, desperate to find enough yield, while the real economy ignores all the fanfare and continues worrying about petty non-issues such as return on investment, retirement income, and kids' college tuition. This causes financial bubbles, the kind that are even worse than those caused by over-heating economy, which at least could drive some productive innovation as in the 90's. This is where we are today.
  2. Where does the Fed channel the liquidity? If they buy up Treasury bonds, it drives down the yield, which implies deflation, the opposite of what they hope to broadcast. They wish Washington would get the hint, take advantage of the free offer, and start issuing enough bonds to drive up yield. And they wish they could actually drop cash from helicopters -- why not, if in the end everyone is better off? Unfortunately for Keynesians, people are not rational beings seeking to maximize their economic interest today. People have children and tomorrow, and make decisions, often less than rational, based on incomplete and/or inaccurate information, with unknown degrees of uncertainty, and using the unreliable, heavily heuristic neurochemical circuitry manufactured by evolution. To Keynes, we all die in the long run; to most people, we worry about tomorrow and our children after our individual "long run." The current U.S. politics is such that binge borrowing is out of question (yes, we could borrow much more if we wanted, for the time being.) As to helicopters dropping cash, money is not just a number to people; it means something upon which our sense of fairness and value is based. Handing out free money beyond necessity, or rather the perception of it, violates that sense of fairness at the emotional level. The central philosophical failure of Keynesianism, in its relentless pursuit of rationalism and quantitative analysis of economics, is that people actually care about future and fairness. Well, a big portion of us do.

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