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QE not key in explaining worrisome market signs

Following up on my last post, a Financial Times chart of the day highlights an inability of QE (quantitative easing) and other central bank activity to explain signs of danger on the bond markets. US tightening is proceeding very slowly and will result in no net tapering of QE at the world level. The markets may be spooked far more by creditworthiness issues than by the prospects of being caught with long-term IOUs as interest rates rise on relatively safe government bonds. Looked at from a broader perspective, there is not much of a tightening in prospect, owing to an anticipated unwinding of QE (longer-term) positions.

More likely a big event—not important in itself—leads to a drastic change in expectations that are not firmly moored in observable variables. As G. L. S. Shackle argued, developing what he called the kaleidic approach in J. M. Keynes’s most famous work, the General Theory,

It is the dependence of [a part of his model representing desires to invest] on expectations concerning distant years which, Keynes insists, makes it sensitive to “the news,” to changes of mood, to ostensibly small-scale events which are treated as straws in the wind and given the power to modify decisively or turn upside down the frail incoherent structure of non-logical inferences and interpretations upon which expectations have to be based.

(from G. L. S. Shackle, The Years of High Theory) (My link is to a publisher webpage; of course, interested readers might also try a seller of used books on a site such as this one.)

This insight leads Keynes and other early Keynesians to the skepticism about the stability of estimated effects from econometric models. As with a kaleidoscope, a completely new pattern can emerge in an instant. Hence, big moves in market valuations occur suddenly and without prior moves in other major variables. This gets at a paper that I have to get back to now, as coauthor Tye takes a well-deserved break.

Nerdy note: I do not see how this aspect of Keynes’s work cannot be made consistent with the valued and important insights of later economists in Keynes’s school–in the sense of a model that incorporates multiple thoughts at the same time in an stock-flow-consistent, Post Keynesian whole. If “kaleidic shifts” can and do occur, why not let them occur in an up-to-date model of that type.

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