December 14, 2010
Did QE2 work?
Having offered my assessment of the effects of the Fed's second round of quantitative easing (QE2), I wanted to mention briefly the takes of some other observers.
Jeremy Siegel writes in today's WSJ:
the rise in long-term Treasury rates does not signal that the Fed's policy has backfired. It is a sign that the Fed's policy is succeeding.
Long-term Treasury rates are influenced positively by economic growth-- which encourages consumers to borrow in anticipation of higher incomes and causes firms to seek funds to expand capacity-- and by inflationary expectations. Long-term Treasury rates are affected negatively by risk aversion: Seeking a safe haven, investors pile into Treasury bonds, running up their prices and lowering their yields.
The Fed's QE2 program has raised expectations of growth and inflation, sending long-term Treasury rates up. It has also lowered risk aversion, which implies rising long-term rates. The evidence for a decline in risk aversion among investors is the shrinkage in the spreads between Treasury and other fixed-income securities, the strong performance of the stock market, and the decline in VIX, the indicator of future stock-market volatility. This means that expectations of accelerating economic growth—and a reduction in the fear of a double-dip recession—are the driving forces behind the rise in rates.
John Cochrane, on the other hand, sees little good about QE2:
All that quantitative easing (QE) does is to restructure the maturity of US government debt in private hands. Now, of all the stories you’ve heard why unemployment is stubbornly high, how plausible is this: "The main problem is the maturity structure of debt. If only Treasury had issued $600 billion more bills and not all these 5 year notes, unemployment wouldn’t be so high. It’s a good thing the Fed can undo this mistake."
Of course that's preposterous. The banking system is awash in liquidity. Banks used to hold about $2 billion dollars of excess reserves. Now, they have about a trillion. If they didn’t lend out this first trillion of extra cash, why would they lend the next $600 billion?
I agree with John that the primary effects of QE2 come from restructuring the maturity of government debt, and that any effects one claims for such a move are necessarily modest. But unlike John, I believe those modest effects are potentially helpful.
Just to reiterate, my position is that when you combine the Fed's actions with the Treasury's, the net effect has been a lengthening rather than shortening of the maturity structure:
given the modest size, pace, and focus of QE2, and given the size and pace at which the Treasury has been issuing long-term debt, the announced QE2 would have been associated with a move in the maturity structure of the opposite direction from that analyzed in our original research. The effects of the combined actions by the Treasury and the Fed would be to increase rather than decrease long-term interest rates.
Posted by James Hamilton at December 14, 2010 05:18 PMdigg this | reddit
Is there data on who has been selling treasuries? I would be curious to know if the Chinese sold some of their debt, or bought less, in a tit for tat with the FED. The FED sends loose policy signals to weaken the dollar down to force China out of the tight band. Did China retaliate by selling some U.S. debt, or buying less, to spark some herd selling and drive up bond rates?
There could be more going on here than meets the eye, as evidenced by Bernanke's 60 minute interview. 60 minutes? Really?
The U.S. would love to see a serious revaluation with China. We want a larger piece of that huge and growing domestic market.
Posted by: tj at December 14, 2010 07:14 PM
Remembering, the following (5ource econbrowser):
Federal reserve purchase of 600 Billion usd LT TBs for the purchase of ST TBs induces a lowering of 15 BP (assets swaps)of the LT yield.
Market s sale of the same amount cannot be hedged.
Who sold en masse?
Posted by: ppcm at December 15, 2010 01:38 AM
try telling a businessman who is faced with paying almost a percent more on a loan for a planned expansion, or a potential home buyer who is suddenly faced with the prospect of paying a percent more for a home loan, that QE2 is working...
Posted by: rjs at December 15, 2010 03:01 AM
Ben is a Zombie Bank!
Posted by: Cedric Regula at December 15, 2010 07:22 AM
Posted by: Estragon at December 15, 2010 09:09 AM
In looking at China's foreign exchange reserves and trying to infer the effects on trade, it is important to distinguish between changes in the value of the existing stock caused by exchange rate changes from those caused by current buying or selling activities. For example, if the stock is measured in dollars but includes a substantial amount of euro reserves, a big depreciation of the euro could result in a reported decline in the dollar stock of China's reserves at the same time that it is making current dollar purchases to keep its currency undervalued (and consequently increasing its trade surplus). Only the current purchasing activity influences current trade flows. If China were to stop new purchases, that would imply its currency is no longer undervalued and that it is no longer taking AD from its trade partners.
Posted by: don at December 15, 2010 10:22 AM
One way QE 'worked' is to put downward pressure on the dollar as it encouraged banks and others to engage in the dollar carry trade. That is O.K., except it works only on those who 'play by the rules.' It does little to currency peggers in Asia (unless it is so large as to export inflation to them), but may be devastating to the euro fringe, which is already reeling from an overvalued euro.
In the past few months, there has been a clear tug of war between the effects of the debt woes of the euro fringe and Ben's shortsighted QE policy. News drawing attention to the fringe's debt woes cause the euro to decline, whereas Ben's actions counter with downward pressure on the dollar. Ben should get out of the game. The actions that need to be taken are against the currency peggers, and his tools are too blunt for the purpose.
Posted by: don at December 15, 2010 10:32 AM
JDH: "The effects of the combined actions by the Treasury and the Fed would be to increase rather than decrease long-term interest rates."
Probably the most rate sensitive area of our economy is housing and it's keyed to long-term rates. When the average person goes home shopping, their lender determines what price they can pay based on income and rates. With a 100bps rise in mortgage rates, that affordable price just dropped 10%.
What positive effect could counter a 10% drop in home affordability? An extra 10% rise in commodities? Or emerging market equities?
Posted by: Bob_in_MA at December 15, 2010 11:22 AM
Fooling economic actors into thinking there exist $600 billion more in saving than actually is the case is bound to have an effect. Initially the effect should be positive, like a shot of whiskey.
But fooling the economy in this way & distorting relative prices is hardly conducive to anything but a Keynesian hangover.
Posted by: Bryce at December 15, 2010 01:16 PM
"...encourages consumers to borrow in anticipation of higher incomes"
This is for the comedy club. I don't know anyone (outside of those in the financial sector who are getting fat bonuses) who anticipates higher income.
Posted by: Anonymous at December 15, 2010 11:32 PM
Insiders — company officers, directors and largest shareholders — presumably know more about their firms’ prospects than do the rest of us. And right now they are selling their companies’ shares at a pace last seen in early 2007.
Posted by: Ivars at December 16, 2010 09:11 AM
Cochrane's arguments leave no room for the effect on the dollar carry trade. He is ultimately right, but only by accident. In a world flush with AD, Ben's QE strategy would provide real help through effects on the foreign sector. But Cochrane is right that there is no chance for a direct effect on domestic investment. Consequently, in a world of deficient AD, Ben's strategy is no more than a short-sighted attempt to beggar already poor neighbors. Some (Brazil, Singapore, st al.) are rightly complaining about the tactic and taking counter measures. Others (euro bloc members) are just suffering.
Posted by: don at December 16, 2010 09:58 AM
banks do not lend out reserves.
neither you, nor cochrane, have any idea how this works
cochrane is correct in that QE2 is just altering term structure of outstanding federal liability though and that this will do little except lower long term rate slightly.
Posted by: zanon at December 17, 2010 07:23 AM
Sadly, QE2 did work. The USGGBE10 (a measure of long run inflation expectations) bottomed out at 1.57% the trading day before Bernanke's Jackson Hole speech (August 25th) and since has risen to about 2.3%.
Note that, it would appear the Fed's goal is to maintain long run inflation expectations in that range.
Thus this is what "mission accomplished" looks like. Anyone who expected the Fed to do more must have been expecting price level or NGDP level targeting.(WELL EXCUSE ME!)
Posted by: Mark A. Sadowski at December 31, 2010 10:48 PM