October 03, 2010
QE2: estimates of the potential effects
As the conviction grows that the Federal Reserve will adopt a second round of quantitative easing (dubbed by some as "QE2"), I thought it might be helpful to survey some of the different estimates of what effect this might have on long-term interest rates.
Although we are used to thinking of the Federal Reserve as playing a key role in determining interest rates, it is far from clear that the Fed matters that much for interest rates at the moment. The Fed's traditional influence comes from changing the supply of reserves injected into the banking system, which in normal times would quickly change the interest rate at which banks lend those reserves to each other overnight. But with over a trillion dollars in excess reserves and the overnight rate practically at zero, the Fed's primary policy tool is completely irrelevant at the moment.
There might still be some ability to affect longer-term interest rates from much more massive operations. The theory is that by taking some of the supply of longer-term bonds off the market, this might raise the price and thus lower the yield on those bonds. There are a number of recent studies that try to measure the potential size of this effect. I've described my own research with Cynthia Wu on this topic to Econbrowser readers, and today would like to take a look at how our estimates compare with those obtained by other researchers.
It's not trivial to make these comparisons, because different researchers have posed the question as to what the Fed might do in different ways, and used different measures to summarize what the effects would be. One benefit of our approach is that it provides a complete description of what would happen to the entire yield curve, both in normal times and in the current environment in which the overnight rate is at the zero lower bound. That allows us to calculate predicted values for the various magnitudes that other researchers have studied.
My paper with Cynthia examined what would happen if the Fed were to have bought $400 billion in long-term Treasuries, using December 2006 as our base for the pre-crisis evaluation. In the pre-crisis environment, it is quite important in our framework to assume that the Fed sterilized this with $400 billion in offsetting sales of short-term Treasuries. By contrast, when at the zero lower bound as now, sterilization is irrelevant, and we have alternative estimates of the effects if the Fed simply purchased $400 billion in long-term securities outright with newly created reserves in the current zero-lower-bound (ZLB) environment.
One of the most influential studies of the effects of such operations is by Joseph Gagnon and colleagues, who report estimates from a variety of methods. The estimate we highlight in the table below comes from a regression of the 10-year Treasury yield on the supply of Treasury debt of more than one-year duration. Gagnon and colleagues measured the latter as a fraction of GDP. A number of other variables thought to influence yields were also included in the regression, which was estimated over 1986:M12 to 2008:M6. Their estimated coefficient on the relative debt supply is 0.069. In 2006:Q4, $400 billion would correspond to about 2.9% of GDP, for a predicted drop in the 10-year yield of (2.9)(0.069) = 20 basis points. By contrast, Cynthia and I would predict about a 14-basis-point decline from such an operation if it had been implemented in December 2006 and almost the same effect if implemented today.
The Gagnon study reported a range of estimates from other methods, some of which would correspond to a predicted effect as low as 12 basis points.
Greenwood and Vayanos arrived at estimates in a rather different way. They regressed the yield spread between assets of different maturities on the share of outstanding Treasury debt that was of more than 10 years in duration. They found that a one-percentage-point increase in the share resulted in a 4-basis-point increase in the 5-year over 1-year spread over the period 1952-2006. In the sample we studied (1990-2007), a maturity swap of the size considered above would have lowered the share of debt with maturity greater than 10 years by 9.8 percentage points, which gives an effect implied by the Greenwood-Vayanos estimates of (9.8)(4) = 39 basis points. By contrast, the estimate based on our empirical analysis of the size of the effect would be 17 basis points if implemented in 2006, but only 9 basis points if implemented in the current environment. The reason for the difference is that, in our framework, part of the drop in the spread if the policy had been implemented in 2006 would have come from an increase in short-term yields, something that would not happen if the same purchase were implemented today.
A third study has just been released by Fed researchers Stefania D'Amico and Thomas King. They look at the change in yields of different maturities during the Fed's purchase of $300 billion in long-term securities between March and October of 2009. They conclude that these purchases lowered the yield on 10-year Treasuries by about 50 basis points, which would translate into an effect of (4/3)(50) = 67 basis points for a $400 B purchase analyzed in the table above. Our estimate of 13 basis points is quite a bit below theirs. However, the 10-year yield was where these purchases were concentrated and where D'Amico and King found the biggest effects, and large standard errors are associated with any of these estimates.
Also last week, Deutsche Bank in the September 29 issue of its Global Economic Perspectives reported "guesstimated effects" of $1 trillion in new long-term security asset purchases by the Fed. These were based on the Gagnon study mentioned above along with separate estimates put together by Macroeconomic Advisers and Deutsche Bank staff. Deutsche Bank's expectation is that $1 trillion in long-term purchases in the current setting might produce a 50-basis-point decline in long-term yields, which we've translated as a 20-basis-point decline for the $400 billion purchase analyzed in the table above.
Given the great differences in the methods by which these estimates were arrived, there is a surprising degree of consensus, at least as far as the rough magnitudes are concerned. Our estimates are a bit below those of other researchers, but everyone has found that there will be some effect if the purchases are of a sufficiently large magnitude. As mentioned above, there is considerable uncertainty associated with any of these estimates.
These also appear to be the sort of numbers that the FOMC may be thinking in terms of as well. In a speech given Friday, Federal Reserve Bank of New York President William Dudley conveyed the following:
some simple calculations based on recent experience suggest that $500 billion of purchases would provide about as much stimulus as a reduction in the federal funds rate of between half a point and three quarters of a point. But this estimate is sensitive to how long market participants expected the Fed to hold on to these assets.
In recent years, a 100-basis-point move in the fed funds rate has translated into about a 40-basis-point move in the 10-year yield (e.g., Table 2 of my 2008 study). Hence if we use the lower end of Dudley's range, we might come up with a number of (400/500)(1/2)(40) = 16 basis points as another ballpark estimate of the effect on the 10-year rate of another $400 B in long-term bond purchases.
But even if we agree that the Fed could depress long-term yields with these kinds of measures, it is a separate question as to whether it should. I discussed this issue a few weeks ago. I remain of the opinion that while the Fed is understandably reluctant to embrace QE2, it may have little other choice.
Posted by James Hamilton at October 3, 2010 05:51 AMdigg this | reddit
Forecast is for bubble storms with continued unemployment.
Interest rates are already so low that it's just pushing on a string. Would 4% mortgages bring out a new wave of home buyers? Would 4% business loans encourage business expansion when we've already got excess capacity?
When Bernanke's only tool is a hammer, every problem looks like a nail.
Posted by: W.C. Varones at October 3, 2010 06:18 AM
In terms of policy punch I think it would be much more useful if we knew or could estimate how much real rates would decrease by the FED's QE. In fact, the macro effects are probably much larger than most who look at nominal yields realize. FED's QE announcement raises inflation expectations which all else being equal should lower real rates.
In fact 5yr forward 5yr break even inflation has been trending higher http://twitpic.com/2qvd3m and is now close to 2.6%.
Posted by: fullcarry at October 3, 2010 06:42 AM
I think market has already reflect the QEII effect. We have seen lower bond yield, rising stock prices, rising commodities prices and lower US dollar.
Bernanke must ask himself that the current bond yield is already supporting the growth and inflation. I am not sure that the lower long term bond yield will support the economy and suitable for long term economic growth.
Posted by: Young Economist at October 3, 2010 06:47 AM
The banks reserves are at historical heigh,their lending capacity is far from being dented through this measure.
Reserve Balances with Federal Reserve Banks, Not Adjusted for Changes in Reserve Requirements
Inter bank loans and borrowings are scarce, a function of a risk factor assessment. Additional liquidity may assist their liabilities funding side but not the debtors solvency.
At some point of time the banking and financial sectors may have to consider selling assets (subsidiaries, participations etc), and to be a drag for their shareholders and bonds holders rather than being subsidized by savers and tax payers.
Central banks are through trials and errors trying to adjust the adequate level of required liquidities but cannot boost solvency or full employment
Posted by: ppcm at October 3, 2010 07:14 AM
On your last question -- the efficacy of lowering rates -- it would be helpful to know which sectors of the economy typically react to lower l.t. rates, and what happens if those sectors don't react? Housing is the obvious, problematic one. Leaving housing aside, what impact would lower rates have on business investment spending? Since most "capacity" is in the service sector, is it reasonable to expect net new firm creation as a result of lower rates? What about consumer durables spending? It has been stagnant (in the PCE report) past in the five months when rates have been falling. Should we expect a reversal?
The Fed argues that the principal impact of QE on growth will occur through lower rates. It seems the larger stimulative effect would come from (indirectly) monetizing projected deficits, possibly for years to come. I say "for years" because, if QE2 is not successful, then discontinuing it would constitute a de-facto tightening of monetary policy at a time when unemployment is unacceptably high. The pressure would come for QE3, then QE4, etc. The key to any stimulus exit plan is success in generating sustained growth. Absent that success, removal of stimulus becomes quite difficult, and that creates a category of risks for the economy.
Posted by: David Pearson at October 3, 2010 07:18 AM
An analysis of what QE2 will do to the economy must include bubbles that will form in response. Not paying attention to where the money is going is how we wound up with the Y2K and housing bubbles. Also consider that inflation is never spread evenly across all sectors of the economy. Computers can go down in price while health care and education are simultaneously experiencing hyper inflation. This is significant, because health care is challenging national and state public budgets, and education is challenging local public budgets.
Posted by: Ekim at October 3, 2010 07:37 AM
At this point, the housing market needs a Super Janitor, not a macroeconomist. We are finding that Wall Street has been selling everyone the Brooklyn Bridge because title transfers haven't occurred properly thru the MBS securitization process. Then I suspect potential buyers of houses built in the last decade are also interested to find out if that cute little house their Realtor(tm) showed them was built with chinese drywall and will kill them in their sleep.
But bring on QE2...what we need is lower interest rates. Maybe we can stimulate China.
Other news is in the CRE market, banks are giving up on restructuring loans at lower interest rates, because things aren't getting better with the basic business. Bring on QE2.
Other news is we have an all time record already in corporate refi, and junk bond refi is now the hot investment area. Bring on QE2.
Other news is the 10 year treasury is 2.5% and the 5 year is 1.25%. Bring on QE2.
Other news is the buck is dropping vs the Euro (?!?) and Yen, but NOT the RMB. Bring on QE2.
So. It is ME that sounds like a broken record??????????????
Posted by: Cedric Regula at October 3, 2010 08:16 AM
I confess to not having read the methods carefully, but I am skeptical that regression results based on the post-war experience will provide much useful insight into the bahavior under current conditions.
D.P. raises the ultimate question - what good will this do? My take is it will have effect on GDP only indirectly - by supporting overvalued asset prices (housing and equities). But the crucial issue is whether it will prevent deflation. I am skeptical - unless people become uncertain about the ability or resolve of the Fed to keep things under control, we will not be able to prevent deflation without threatening very ugly inflation.
Cedric - a number of intesting stories circulating about the resurgence of the euro, in the face of a possible breakup of the euro bloc. One is that China, which apparently pledged to keep the value of the euro 'stable' is playing a major role. My take is that it is Ben's actions, but I know China has been buying bonds of some struggling euro members, claiming to be doing them a favor by showing 'faith' in their credit worthiness. That may be true temporarily for the struggling members (but maybe not - they need to decouple themseves from the euro and repudiate the loans), but not for the other euro members.
The buck is not falling much versus the yen - they are in intervention mode. Krugman is becoming much more strident with the opinion that this has got to stop.
Posted by: don at October 3, 2010 02:38 PM
JDH mentioned in his prior post that he would prefer fiscal stimulus to QE.
Part of the problem with the federal government's fiscal stimulus is that it is hard to get the money out the door and it encourages inefficient spending. Why not implement a negative federal sales tax? This would have to include a proviso that if a state raised its sales tax the negative sales tax would be reduced by the same amount.
Rather than feeding particular Congress members' pet projects or government industrial policy or targeting particular sectors such as homebuilding or public construction, this would target retail sales, which affects all sectors. It has the advantage of putting control over who gets the stimulus in the hands of individuals rather than bureaucrats or the well connected.
One concern might be that this would only stimulate countervailing retail price increases. Although I doubt that, even so this would certainly help solve the Fed's inflation targeting problem.
The biggest problem with that is the election, which promises to put a lot of budget hawks in power. But perhaps this would appeal to some of them more than public works projects.
Posted by: colonelmoore at October 3, 2010 10:04 PM
Previously you mentioned that you and Cynthia (hmmm...I suspect mainly Cynthia :->) did quite a bit of database cleansing as part of your analysis. Any sense as to how much of the divergence between your estimates and those of other researchers is due to your using a cleaner database? In other words, did a cleaner database increase or decrease your estimated basis point responses?
Posted by: 2slugbaits at October 4, 2010 05:18 AM
W.C. Varones "When Bernanke's only tool is a hammer, every problem looks like a nail."
If our politicians had any sense then they would look to their own toolbelt instead of shifting blame to the Fed. In the current environment the proper remedy is fiscal policy. If our braindead politicians worried more about the economy and less about their personal ambitions, then maybe Bernanke wouldn't have to be thinking about "hail Mary" efforts like QE2. QE2 is a last ditch effort that may or may not work and carries with it a lot of risk to the Fed's balance sheet. The only reason we're even talking about it is because our politicians refuse to act like grown-ups. Sadly, voters will probably reward those same politicians come November.
Posted by: 2slugbaits at October 4, 2010 06:07 AM
2slugbaits: I suspect that the most important difference is that our estimates are based on a forecast that conditions on current interest rates, whereas the others are primarily based on contemporaneous correlations.
Posted by: JDH at October 4, 2010 06:52 AM
I remain of the opinion that while the Fed is understandably reluctant to embrace QE2, it may have little other choice.
Whatever happened to, "First, do no harm." Of course they have a choice. They can do nothing. They have certainly demonstrated that what they have been doing is harmful, or at best nothing at all anyway.
Posted by: Ricardo at October 4, 2010 11:23 AM
From CNN Money:
"Put simply, [Meredith Whitney's] study [The Tragedy of the Commons] warns that the giant gap between states' spending and their tax revenues, estimated at $192 billion or 27% [!] of their total budgets for the 2010 fiscal year, presents two dangers that investors are seriously underestimating. First, municipalities could start defaulting on their bonds guaranteed by the cities and towns themselves, an exceedingly rare event over the past three, mostly prosperous, decades.
"People keep saying it can't happen, just as they said national housing prices could never go down," says Whitney. "Now, it's a real danger."
The reason: the municipalities receive one-third of their revenue from the states. If the states hold back that money for their own stricken budgets, towns and cities won't have the funds to make their interest payments. "It has to happen," says Whitney. "The states will secure their own shortfalls, and leave the cities to fend for themselves." It's all about inter-dependency, she says, with the federal government aiding the states, and the states funding the last and most vulnerable link, the municipalities.
Housing fallout continues
Second, Whitney sees the budget shortfalls as a far stronger leash on both employment growth and overall expansion than investors realize. The common thread between the banking and looming state financial crises, she says, is housing. "The entire financial system was over-leveraged to real estate," says Whitney. "So were the states."
During the boom years from 2000 to 2008, the states that grew the fastest were the ones where housing prices grew fastest, and where construction flourished, including California, Florida, New York, and New Jersey. In Florida, almost 30% of income growth came from real estate, an astoundingly high figure. Tax revenues soared during the real estate frenzy, and spending soared along with them. Now, revenues have collapsed with housing prices, and spending is proving far stickier. The legacy: Today's gigantic deficits.
Then, as housing prices fell, the states that grew the fastest and outperformed in the strong years, are now posting the worst economic performance––for the obvious reasons that they face the biggest mortgage delinquency and foreclosure rates, as well as high unemployment due to the collapse in construction and mortgage lending. The "haves," says Whitney, have suddenly evolved into the "have-nots."
The problem is that the states that benefited disproportionately from housing are generally the biggest economies, so their woes have become a deadweight on overall economic growth. "Other states such as Nebraska, even with larger ones like Texas, aren't large enough in total to offset the weak growth in the states that depended on real estate," says Whitney.
What investors are missing, says Whitney, is that growth in those states is destined to remain feeble because of the drastic measures needed to redeem their finances. By law, almost all states are required to balance their budgets. Right now, the Obama stimulus package is making up over $60 billion of the $192 billion shortfall for fiscal 2010. But that money is slated to disappear next year. States are already raising taxes, or planning to -- voters in Washington will soon vote on a referendum to levy an income tax.
The biggest source of funds to fill the still-giant gaps is especially worrisome: Raiding pension and healthcare funds. States from California to New York are shifting contributions needed to pay workers' benefits in the future toward funding current expenses.
The housing collapse will leave a different legacy by forcing big tax increases, and cutbacks in benefits including a rise in retirement ages. Millionaires who provide a huge share of the revenues will leave the high tax states, leaving the poor who need most of the services.
"The scary thing," says Whitney, "is that no one wants to talk about it. When you get the data and mechanics together the situation is as basic as it was for banks or consumers." "The Tragedy of the Commons" should get people talking, and the daunting scale of the numbers should get them outraged."
Posted by: Steven Kopits at October 4, 2010 11:51 AM
Have you heard any talk in the oil trading biz if QE2 may be the spark that sets off another oil spike, either by commodity traders or the producers themselves?
My gut tells me that's another downside risk, in addition to hampering the Fed's ability to control inflation someday.
Posted by: Cedric Regula at October 4, 2010 01:30 PM
Cedric Regula: "...QE2 may be the spark that sets off another oil spike..."
I'm not following you here. What do you mean by "oil spikes"? Are you referring to spikes in production or price spikes. To the extent that oil producers act as maximizers of Hotelling rents (and I'll grant you that there's not a lot of evidence that oil prices follow a Hotelling model), wouldn't we expect a successful QE2 policy to increase current oil production and lower price? According to the standard Hotelling model commodity prices of a nonrenewable and exhaustible resource move in the same direction as the interest rate.
Posted by: 2slugbaits at October 4, 2010 02:31 PM
I repeat, for the third time in two years:
Until the consumer is out from the debt or the banks are willing to take the risk of refinancing that debt, read not just folks with 740+ credit ratings, but well under 650, at a much lower rate and maybe some write-offs, the economy in this Country cannot recover. It will be during the period of 2013-2017 that the economy and the jobs will recover sufficiently to begin working the U.S. deficit and debt, DOWN. If the U.S. Government tightens its spending prior to the above mentioned timing, we are in for a long, dark period in which there may never be a recovery.
An Administration change in Washington D.C. will also be necessary as entrepreneurs who have patents waiting and cannot get them due to a shut down of issuance are sitting on the sidelines.
I could have 7 full time and up to 12 seasonal employees in a start up business right now, but no one is going to use their own capital on start up with all the undetermined tax, regulation (Obamacare) and Government oversite of the process.
Until stability is returned to the playing field, no one is up for a risk. Face it money to drive the economy is in lock down.
Posted by: Steve at October 4, 2010 02:46 PM
JDH: Thanks for the post. But one thing confuses me --
"By contrast, the estimate based on our empirical analysis of the size of the effect would be 17 basis points if implemented in 2006, but only 9 basis points if implemented in the current environment. The reason for the difference is that, in our framework, part of the drop in the spread if the policy had been implemented in 2006 would have come from an increase in short-term yields, something that would not happen if the same purchase were implemented today."
I don't understand why short-term rates would change. I see the short-term rate as the price that someone is willing to pay (in the form of foregone interest) to hold money that's legal for transactions, as opposed to risk-free very-short-term govt debt -- a virtually perfect substitute, except non-transactable. The hypothesized swap of short-term for long-term treasuries doesn't change the supply of transactable money, nor the demand for transactability, so I don't see why its price would change.
Posted by: lilnev at October 4, 2010 03:31 PM
lilnev: The short-term interest rate referred to here is that on a 1-year Treasury note. These paid 5% interest in December 2006, the date at which the statement you quote refers to. A one-year Treasury note at that time was not equivalent to cash, and the scenario described would have significantly increased the supply of 1-year and related-maturity Treasuries.
Posted by: JDH at October 4, 2010 03:57 PM
I mean price spike, like when it went to $140.
Not sure about Hotteling, but sometimes OPEC believes leaving the oil in ground and waiting for higher prices is a lot like banking.
Then sometimes traders, or the chinese, get excited about oil, because they think it is even better than "hard currecy" like gold and silver.
These people don't see an upside to the Fed doing QE.
Posted by: Cedric Regula at October 4, 2010 04:06 PM
QE2 brings up some interesting points. The FED can make unlimited purchases of Treasury Securities. Exchanging all treasury securities for reserves, the National Debt could be eliminated - correct? The Fed could then control inflation by raising the interest rate it pays on reserves. The Treasury would no longer have to sell securities (no new debt issued). The FED would just credit reserves for all treasury spending above taxation. If I am wrong please explain why JDH. Because the FED can create unlimited reserves Treasury spending would have no limit other than exceeding the supply of goods and services available for purchase which would lead to inflation. This means there is no solvency or bankruptcy issue for the Treasury (including all those so called "unfunded liabilities" like Social Security and Medicare). Again, if I am wrong please explain why JDH.
Posted by: markg at October 4, 2010 04:11 PM
The treasury is still issuing official debt, and until they fold the OMB into the Fed, and tell them Yellen is there new boss, the OMB reports it as the National Debt.
It's been tried before. People end up believing it's fake money,especially all the people holding the debt that the Fed will exchange electronic dollar credits for, no matter how hard governments try to convince them otherwise.
Next thing you know OPEC AND Russia tells US our money is no good.
Just a slippery slope from there.
Posted by: Cedric Regula at October 4, 2010 05:57 PM
markg: Every asset can be thought of in terms of demand and supply, including Federal Reserve deposits. Under your proposal, the supply of deposits would be, say $9 trillion. And what makes the demand equal to $9 trillion? Your answer is, the interest rate that the Fed promises to pay. And with what do they pay this interest? By creating even more reserves next month, is your apparent answer.
And can the government just create wealth out of nothing with this Ponzi scheme? My answer is certainly not. My answer is that the consolidated balance sheet of the Fed and Treasury is subject to an intertemporal budget balance requirement, such that the real resources that the government uses to purchase goods and services are balanced over time by the real resources that the private sector delivers to it in the form of tax revenues and seigniorage.
If we were to try your plan, the government would acquire resources equal to the outstanding debt, and the seigniorage would come in the form of a mighty impressive rate of inflation.
In other words, my answer is the same as Cedric Regula's.
Posted by: JDH at October 4, 2010 06:39 PM
What's the difference between the Treasury paying interest on $9 trillion in Treasury Securities with an average yield of (let's say) 3% or the Fed paying 3% on $9 trillion in reserves?
And this is not my plan, I am just trying to explore the realities of our monetary system.
Posted by: markg at October 5, 2010 04:41 AM
markg: There is very little difference. But neither the Fed nor the Treasury can continually make those interest payments simply by issuing new debt.
You can't borrow money and pay it back by borrowing even more money. And neither can the Treasury, and neither can the Fed. There is a source of revenue, which I referred to as seigniorage, which is not available to you but is available to the Treasury (because its liabilities, T-bills, are regarded as particularly attractive and convenient) and to the Fed (because the same is true of its liabilities, cash). But the level of seigniorage that can be collected without inflation is limited by the size of GDP and the special demand for these assets. The demand for these assets is not infinite, and that is why the government's ability to buy stuff with the liabilities it creates is not infinite.
Posted by: JDH at October 5, 2010 06:19 AM
The Fed and Treasury are not real people. Real people get nervous when they are excluded from voting with their wallet on the issue of what their money is worth.
It's sort of the same when Skynet on Wall Street is all the volume in stocks. Individuals don't like narrow kleptocracies.
Posted by: Cedric Regula at October 5, 2010 08:31 AM
I don't see why, or how, the monetary transmission mechanism's impact (with open market operations of the buying type), is assumed to be transmitted thru interest rates in the main, as opposed to being transmitted thru an expansion of the money stock (aggregate monetary purchasing power).
With IORs being the functional equivalent of required reserves (i.e., the current definition of excess reserves is obsolete); & with the BOG's remuneration rate @ .25% on excess reserves (IBDDs), now exceeding the "Daily Treasury Yield Curve" all the way out to 1 full year (which QE2 will extend); it becomes more problematic (that crediting the government securities owner's bank accounts) will lead the trade-oriented primary dealers (& their investment management team), to repurchase similar low-yielding coupons, (as opposed to seeking higher returns, by buying yen, base metals, or stocks).
That is speculation (riskier behavior), & a higher price-level, is a by-product of an easier money policy (the housing bubble represented this extreme lesson).
Posted by: flow5 at October 5, 2010 09:04 AM
I think we are in complete agreement. The two big questions are: What is the level of assets (govt debt) being demanded by the private sector? And, what is the potential size of gdp?
Posted by: markg at October 5, 2010 09:23 AM
I have heard traders express the notion that QE2 could lead to oil price inflation. However, when it comes to macroecon, I'd rather take my cues from Jim and Menzie.
Another 2008 oil price spike is unlikely through 2011, as the Saudi's have some 5 mbpd of spare capacity. However, a price spike from 2013 or so cannot be precluded, and, if I were forced to take a stand, looks more likely than not from 2014.
Material prices spikes are historically resolved with recessions--something to consider when planning deficits.
Posted by: Steven Kopits at October 5, 2010 11:14 AM
It seems strange that so many of the commenters here who are so excercised about the risk of inflation from QE2 are utterly oblivious to the far greater risk of inflation due to a permanently higher NAIRU if we don't get the economy moving now. Imagine 10 or 15 years of 2 percent GDP growth and unemployment hanging around 10 percent...and if the knuckledraggers win big in November that's what we could be looking at. What we have today is primarily a cyclical unemployment problem, but some politicians seem hell bent on turning it into a permanent structural problem. Then see what happens when politicians eventually try to using stimulus policies to drive down structural unemployment. I think that's a much bigger risk of inflation than anything that might come out of QE2.
Posted by: 2slugbaits at October 5, 2010 03:15 PM
I think some people may frame the question as "Should we do QE2,3,4...etc...and fix the economy, or shall we just worry about imaginary inflationary effects and not do QE."
I prefer to frame it as" "Does QE have any efficacy we can put our finger on, and are there some downside risks, so maybe it's not a try it and see if it works type of decision."
Here's a GS economist's interview more along those lines. (note: the GS economics department still survives in relatively high regard.)
Posted by: Cedric Regula at October 5, 2010 04:24 PM
Very interesting tread.
I think markg nailed the core issue:
"What is the level of assets (govt debt) being demanded by the private sector? And, what is the potential size of gdp?"
Posted by: Qc at October 5, 2010 05:59 PM
We already know the government is projecting about a trillion of "supply" in treasury bills, notes and bonds next year. If we are lucky the private sector may "demand" it all. But then the Fed says they may "demand" that trillion in QE2 next year, so the private sector will see their "demand" unsatiated.
So if this unsatiated private demand decides it didn't want savings/investment after all, maybe we can add a trillion in Cadillac sales to GDP.
Or maybe not.
Posted by: Cedric Regula at October 5, 2010 07:39 PM
The private sector desires savings. If they didn't, they would net borrow and the government would be in surplus.
Deficits are a reflection of the private sector's desired savings. If the government "spent too much" the private sector would be too rich. Private spending would take off. Together private and public spending would drive inflation.
But, if private spending (net borrowing) and inflation take-off then the government would be in surplus. The existence of a deficit is proof of the desire of the private sector to net save, which is allowed by the creation of government liabilities (and the corresponding creation of money by commercial banks in their role as a financial intermediaries).
It is good that the private sector desires deficits, because household balance sheets in many developed countries are currently impaired.
Furthermore, we know we have excess capacity because of fantastically high unemployment. Savings only foster investment in a full employment scenario, whereby a person saves money. Therefore, that person consumes less. A corporations income declines (because of lost sales), they fire a worker, who is rehired by another firm that is investing to increase future output.
With high unemployment, nobody needs to save to increase investment. The unemployed workers can build investments without sacrificing consumption, they just need to be paid and be directed to build capital goods. Loans create deposits and investment creates its own savings. Everyone is better off. If corporations aren't willing to invest, the government must.
Full payroll tax holiday for everyone. Taxes are destroying aggregate demand. Why are we taking money away from people that are not consuming enough because they don't have enough money. Wake up, America.
Posted by: BD at October 6, 2010 09:32 AM
wonder why you overlook the effects on exchange rate ( NEER or DXY), is the 20% drop in DXY more meaningful than the 20-30bp drop in 10 year yield ?
Posted by: isaac at October 7, 2010 03:24 AM
Now I see why Warren Buffett and Gates are loading up on China!!! The market may soar on false pretenses. Then investors start profit taking, then market collapses. US is left holding the bag. China the new Economic Super Power....I guess we have to wait and see!!!
Posted by: MarketMaster at October 8, 2010 11:52 AM