A brain teaser about QE3

[Hend Abuenein]

Hi everyone,

David, Suzanne, I didn't know where to post this. So please excuse me.

This has been teasing my brain since the Fed's last unveiled plan of economic "stimulus".

My understanding of QE is that the Fed prints money, injects it in the economy through public expenditure, increasing the money in circulations as well as reducing possibility of a shutdown.

Here's the brain teaser:
If the government of the US can print money and spend it on public services, then why does it need to tax people?
Taxation is how taxpayers contribute to the expenditure on public services they will benefit from (health, education, infrastructure...etc)...but now that Fed found a source of money generation other than taxing people, why don't they stop taxing people as a part of the quantitative easing on the private sector?

 

[ShaktiRathore]

This is according to my understanding:
Govt. can print money and use it for public expenditure. If govt. does not tax people than people now have full income with them and hence more money to spend. So if earlier they had 65to spend now they are left with 100 to spend.
Govt. if want to spend say amount 35 than it can raise it through printing money or taxing the people. If it prints money for expenditure (35) and also If it does not taxes people than total amount of money in the economy is 35+100=135. If on the other hand if there is tax on people than total amount of money remains at 100(35 for govt,65 left for people). So there is a rise of (135-100/100)35% in the amount of money in the economy with no taxing. This is very high level rise of money in the economy which can cause alarming levels of inflation. High inflation leads to low interest rates which can jeopardize the investments in the economy.
Govt. also borrow money for such developmental tasks through raising debts and issuing T-bills but it creates an obligation on the part of the govt. Raising money through taxes provides no such obligation and is a direct source of income.
The raising of money through taxes and investing in development is a matter of fiscal policy whereas printing of money and its circulation through lending is a matter of monetary policy. So raising money through taxes or through printing money are entirely different prospects. While monetary policy controls the inflation and affects interest rates, the tax policy affects govt. expenditure and revenue.
Printing money will only raise prices as is evident from the fisher equation PG=MV where Price,G:growth,M:money supply and V:velocity of money and cause more inflation. Inflation is an evil which is tamed through monetary policy and if the case here is unnecessary printing of money that can cause inflation a cause of worry. Such policy of meeting expenditure through printing can cause hyperinflations and can run the economy into trouble. So a stable fiscal policy should be the focus.

thanks

 

[Ashwin FRM]

in 2006, US tax revenues were $2.6 Trillion USD. so $40B/Month, as in QE3, is small relative to that, and it is targeting MBS, to lower mortgage rates and stabilize stock market. It is surely inflationary like QE1 and QE2, and is clearly prevalent in anything we buy ( food and gas in particular). Not taxing will just make USD worthless, we may have to use a wheelbarrow of dollars to buy a loaf .

Having said all this, I myself wonder why the Fed does not find a way to lend money to home owners directly, if the banks wont; or guarantee home loans like FHA; or offer refinance on homes at lower rates for bad mortgages so that toxic MBS are prepaid and resolved, rather than indirectly pumping up the money supply causing banks to have even more extra reserves which they are not lending. A direct solution to the problems is far better.

 

[Hend Abuenein]

Hi ShaktiRathore ,
I hope you're doing well.

1- You assume that the fiscal policy and monetary policy of the same country are totally independent, and that therefor their plans and aims must be for different purposes. But they are in the same economy, and of the same government running the same country. If they are as you explain: totally separated and independent, when their economy suffers the same, then this situation is wrong and government must change it.

2- You said that NOT taxing people under QE will cause inflation, but then you said that printing money regardless of taxing people will also cause inflation. Question here is if we are having the inflation anyway, so we might as well not tax people and give them some money to spend on that inflation

3- Though irrelevant to subject here: I disagree with what you said about low interest rates jeopardizing investment. I think it's the other way around. In my understanding : The lower the interest rate, the more people will put into investments instead of in bank deposits.

mathless FRM Thanks for sharing thoughts on that. I didn't know that QE3 was directed towards MBSs specifically.

 

[ShaktiRathore]

Hi @Hend,
regarding point 3 yeah sorry for the wrong wording I meant here to say that high inflation leads to high interest rates which can jeopardize the investment. I mean i didn't revised it after answering. I agree on this point.
regarding point 2 printing more money always increases the circulation of money so there is inflation. And this can happen regardless of taxing people. I mean to say that cumulatively not taxing people and printing money can increase overall supply of money and thus cause inflation.
regarding point 1 i want to make you clear that monetary policy deals with changing interest rates and ensure growth without too much inflation. Fiscal policy deals with govt. revenues(taxes including) and expenditures. Seeing by their functions we can say they are relatively independent. But as you said not taxing people but without collecting the taxes which is a major source of revenue for the govt. how can govt spend for expenditure and if govt. can do it without taxation and with printing money than ask monetary policy department what it will cause(inflation).If you give this responsibility to fiscal dept. than what is the role of raising and decreasing interest rates which is the role of monetary policy. I mean collecting revenues and spending is totally different from manipulating interest rates. if controlling money supply is given to fiscal dept. than there is no role for monetary authority and then as you said can be combined into one body but don't you think that the functions of these departments are different and should be left as they are. If you are intermingling these than a lot of confusion can arise(fiscal dept. printing money and then monetary dept. also printing money there is no sort of coordination). Even if you combine both departments the variety of roles one has to perform within one body will eventually shed off these as distinct major responsibilities in the end than i think its better to let them do their parts.I mean to achieve something clarity is important and objective should be simple and achievable. chasing too many objectives at one time is not good.

thanks

 

[troubleshooter]

They can print as much money as they wish but the unavoidable consequence by doing that is the inflation as pointed out by earlier posters. QE3 will cuase inflation too but substituting tax revenue by new paper money would cause super hyper inflation as there will be much more money in the economy chasing the same amount of goods and services. Just to illustrate this, if everyone in the country has at least 10 million dollars ecah, then value of that dollar must decline. This is the reason that you do not print too much money. QE3 however will not print that much money to make everyone a multi-millionare but it will still cuase inflation. It will not be liked by the holders of treasury debt as they will be paid in cheaper dollars than what they lent. In future, US treasury will be forced pay much higher rates while issuing the securities. Too much QE is not good in the long run, though it will stimulate the economy in the short term but not without adverse consequences...

 

[Ashwin FRM]

Hend, a good question, seemed very ordinary though. ShaktiRathore elucidated with details. The reason that the MP (monetary policy) and FP(Fiscal Policies ) are under different controls, I think, is because of purely technical issues. Federal Reserve, holder of MP, was created in 1913 in response to bank failures and crashes, especially the panic of 1907 (http://en.wikipedia.org/wiki/Federal_Reserve_System) It seems clear to me that congress which are full of lawyers wanted to create another body to take care of Monetary policy. They could have created a subcommittee to do that but for some reason felt that it should be handled separately. Fed is now totally autonomous body, without having to do what president or congress want it to do. However, that is in theory, but in reality, Fed chairman is picked by the president, so a new president can pick another one as the chairman term expires, so it is obligated to side president. Like ShakiRathore said both MP and FP can raise money supply. They are both inflationary.

while increase in money supply decreases interest rates, this works only up to a point while the factory capacity is exists. there comes a time when extra production is costly. then the demand needs to be curbed. This happend in 81 when the interest rates had to be raised to 20% or so to curb inflation running at 13.5%. It caused the recession of '82 and tamed (per ShakiRathore) the inflation to be 3.2%. One disadvantage of high inflation, in the '70's, was that economic growth slowed, unemployment persistently high, called stagflation. (http://en.wikipedia.org/wiki/Paul_Volcker)

Whether MP and FP should be merged or not is topic of intense debate on the internet. To me it seems it is better to be separate than not, so that there are checks and balances.

 

[Mark W]

If the government of the US can print money and spend it on public services, then why does it need to tax people?
Taxation is how taxpayers contribute to the expenditure on public services they will benefit from (health, education, infrastructure...etc)...but now that Fed found a source of money generation other than taxing people, why don't they stop taxing people as a part of the quantitative easing on the private sector?

What value does the money have if it's being printed willy nilly? Read http://en.wikipedia.org/wiki/Money#Functions

 

[Aleksander Hansen]

...but now that Fed found a source of money generation other than taxing people, why don't they stop taxing people as a part of the quantitative easing on the private sector?

Hend, the answer is very easy:
Printing money is identical to taxing the populace.

Inflation is a tax in several ways:
1) your purchasing power of real goods and services is decreased
2) you push the tax-payer base up to a higher tax-bracket

Analogously, borrowing money is also a tax.

There is no fundamental difference between: printing money, selling Treasury's, direct taxation. They are all taxes, that is, a unilaterally enforced transfer of funds from one person to "the Government".

Now, the whole premise of the question, " why does Government do...?" is a non-starter. The Government does all sorts of silly things. For example, they throw Madoff in jail, whilst continuing the biggest Ponzi scheme the world has ever seen: Social Security, Medicare and Medicaid. These are all, as documented in the report by the secretary of finance of Social Security, "pay-as-you-go systems." In other words, the people at the bottom of the pyramid are just like the victims of Madoff's scheme. That is to say that these programs are merely Ponzi schemes writ large.

 

[orang3eph]

Aleksander is right; printing money is very much like taxation is some regards. And make no mistake, it is a great source of income for governments all over the world. For more, see Robert Mugabe, the avant-gardist of seigniorage.

Also, I'm pretty sure QE is not government expenditures; the money is supposed to buoy fixed income markets. I think countercyclical increases in govexp need to go through Congress(?).

 

[Aleksander Hansen]

Aleksander is right; printing money is very much like taxation is some regards. And make no mistake, it is a great source of income for governments all over the world. For more, see Robert Mugabe, the avant-gardist of seigniorage.

Also, I'm pretty sure QE is not government expenditures; the money is supposed to buoy fixed income markets. I think countercyclical increases in govexp need to go through Congress(?).

They do need to go through Congress if implemented by the Executive Branch. However, the Board of Governors of the Federal Reserve System has discretion to do a lot through their dual mandate of full-employment and low inflation.

Robert Mugabe, yeah, he's a clever fellow... take one of the most prosperous economies on the continent of Africa and demolish it from the inside.
Another case of the highly unfortunate effects of inflation is the Weimar Republic and the war-reparations they were forced to pay, causing money to be used as wall-paper, and requiring baskets full in order to buy a loaf of bread. We all know what that lead to.