hamster143 said:
The only semi-credible source I could find that was willing to go on record on this subject, predicted gains of 0.5% of GDP, as a result of quantitative easing on the scale of 10% of GDP, giving the multiplier of 0.05
Forgetting for a moment that I see no reason to regard Mr. Hatzius' comments as anything more than idle speculation, we need to correct your numbers a bit. The scale of QE2 is approximately 3.5% of U.S. GDP, and I believe this analyst was referring to a 0.5% initial boost in
growth rates over the term (though the article is admittedly poorly written), and not trying to quantify net cumulative effects.
In the long run, the benefits to GDP growth will outlast the term of the Fed's program, due to the multiplier effect. You need to be more critical in your analysis.
But the original point was that holding currency is functionally equivalent to holding short term bonds when the interest rate is zero.
Alright, I see what you are saying. Yes, it is
conceivable that there could be
functional equivalence, as defined by return on investment. But cash is not an investment, and people typically do not hold it as a store of value (even in a money market account), but instead hold it to finance transactions and protect wealth. Even if the case of functional equivalence, people would not see cash as an investment, but as a protection against the risks of the (poorly performing) bond market.
In practice, this sort of environment would incentivize borrowing and provide a disincentive to lend, driving interest rates up quickly. Further, no lender would agree to loan money at a 0% rate of return, and no matter how high bond prices rose yields on positive-return bonds could never, mathematically, fall to 0. The bond market may approach but never reach 0,
nominally.
Real rates - after adjusting for inflation, transaction costs, and market risk - can both fall to zero and invert, though.
This is not true when the real interest rate is zero: assuming 2% inflation, riskless bonds pay 2% nominal, cash pays 0% nominal, and bonds are clearly preferable to cash.
I think your misunderstanding the difference between real and nominal rates.
In your example, given 2% inflation, the real return on bonds is 0%, but the real "return" on cash is -2%. You are correct though - bonds here are preferable to cash.
Imagine instead an environment where the yield on bonds was 0% and the inflation rate was 0%. In this case, bonds and cash are functionally equivalent. Are bonds preferable to cash in a profit maximizers mind? No, in fact there's no profit incentive to lend. On the other hand, there is tremendous incentive to borrow. The loanable funds market would tend to zero.
