Bon Voyage, QE2

Time for another visit from the Marshallian K. For those who even remember this obscure economic theory we’re sorry to have to go over this again, but we have to go over this again. The theory goes that excess money in the economy (that is money supply over and above the transaction demand for money, or the price of goods times the volume of goods divided by the velocity of money) will seek its best use and that use is usually in the securities markets in the short run. Money can be more effective when used for investment in physical plant and equipment or inventories or some other largely illiquid investment. But, when the supply of money rises suddenly the easiest way to make that money return anything is to put it in the securities markets (think in terms like putting it in a money market fund instead of as cash in your pocket). So, when QE2 began last October the securities markets started rising, though not right away. This is an element in the Fed’s outlook that the end of QE2 won’t have a meaningful impact on the real economy. Most of this money never reached the real economy in the first place. Read more