(Originally published here.)
Bloomberg News reported on Wednesday that James Flaherty, the Canadian finance minister, said that the Federal Reserve was “printing money” and that this was “not good public policy” at a recent meeting of the Group of 20 finance ministers and central bankers. Like most secretive and unaccountable institutions, the Fed has made many other mistakes over its 100-year history, so it isn’t unreasonable for Flaherty think that it is doing so again.
His criticism, however, leaves something to be desired. The Fed’s asset purchases (quantitative easing is the more common, but confusing term) are different from printing money. That’s good if you are worried about needing wheelbarrows of cash to buy groceries, but it also explains why rich countries that have been copying the Fed have not been able to escape years of anemic growth.
Most of what people think of as money is really short-term debt issued by banks and other financial institutions. Those institutions expand and contract their balance sheets — print and destroy money — according to a vast array of factors: The number of credit-worthy borrowers, regulatory requirements and projections of future growth all influence the banks’ decisions. Monetary policy certainly affects banks’ incentives to create money, but this mostly seems to be because central banks can alter the level of interest rates, at least short-term ones. Moreover, monetary policy is just one force among many.
There is no relationship, however, between the Fed’s asset purchases and the money supply. Mark Dow has persuasively argued that there is no relationship between the quantity of broad money and the size of the Fed’s balance sheet. He thinks that the impact of the asset purchases has been mostly psychological and that “if we all understood monetary policy better, the Fed’s policies would be working far less well.”
So what could Flaherty be complaining about? Unfortunately, the comments occurred at a private dinner and the finance minister declined to provide additional context or insight. Analysts say he might have been concerned about the perceived impact of the Fed’s asset purchases on the exchange value of the Canadian dollar. That isn’t the Fed’s problem. If Flaherty really thinks the Loonie is overvalued, he should do what the Chinese, Singaporeans, and Swiss all do: announce an exchange-rate target and promise to buy as many foreign assets as needed to hit it. That would be a bold move, though — one that doesn’t fit with his reticence to explain his Loonie opinions about U.S. monetary policy.
(Matthew C. Klein is a writer for Bloomberg View. Follow him on Twitter.)