July 02, 2011
The effectiveness of quantitative easing
This week I attended a conference hosted by the Federal Reserve Bank of St. Louis on quantitative easing. The purpose of the conference, as explained by Bank President James Bullard in his opening remarks, was to answer Stanford Professor John Taylor's challenge to provide research of real-time usefulness to policy makers. The conference featured analyses by 5 different research teams of the effects of recent quantitative easing measures adopted in the United States and United Kingdom.
Here are the 5 papers presented at the conference, 4 of which we've already called to the attention of readers of Econbrowser (with links to Menzie's and my earlier discussions provided for convenience):
- Large-Scale Asset Purchases by the Federal Reserve: Did They Work? by Joseph Gagnon, Matthew Raskin, Julie Remache and Brian Sack (see Econbrowser October 2010).
- The Large-Scale Asset Purchases Had Large International Effects by Chris Neely (see Econbrowser July 2010).
- The Effectiveness of Alternative Monetary Policy Tools in a Zero Lower Bound Environment, which is my paper with Cynthia Wu (see Econbrowser August 2010, December 2010, and February 2011).
- The Financial Market Impact of Quantitative Easing by Michael Joyce, Ana Lasaosa, Ibrahim Stevens and Matthew Tong.
- Flow and Stock Effects of Large-Scale Treasury Purchases by Stefania D’Amico and Thomas King (see Econbrowser October 2010).
The conference began with a summary by Federal Reserve Bank President James Bullard of what the Fed was trying to accomplish with QE2 and the effects he believes the program had. Bullard suggested that the Fed's goal of the large-scale asset purchases initiated in November 2010 was to make sure that the United States did not repeat the policy errors made by Japan. Bullard began by noting research by Jess Benhabib, Stephanie Schmitt-Groheb and Martin Uribec on some additional reasons an economy could get stuck in a liquidity trap. The diagram below, taken from Bullard's presentation, plots a Fisher relation (higher nominal interest rates are associated in long-run equilibrium with higher inflation) as the straight dashed line. The Taylor Principle calls for increasing the Fed's target interest rate more than one-for-one in response to higher inflation, as represented by the upward-sloping section of the solid black curve. But because of the zero lower bound on interest rates, that means globally the Taylor Rule has to look like the indicated curve, with a bad equilibrium associated with a zero interest rate. The actual U.S. data are represented by blue squares. Bullard noted that whatever you want to make of the theory, the practical experience is that Japan seems very much to have been stuck in the bad equilibrium, as represented by the green circles.
Bullard argued that Chairman Bernanke had communicated the Fed's intention to implement QE2 in his speech at Jackson Hole August 27, and that the effects had been fully priced in by markets by the time the actual bond purchases began in November 3. That was also the interpretation I had offered at the time. Bullard felt that the changes in the fall of 2010 were in the direction that the policy might have been expected to achieve. Expected inflation increased between August 27 and November 3.
The dollar depreciated.
Real interest rates declined.
And equity prices increased.
I believe it is quite accurate to say that many of us were concerned last summer about the danger of the U.S. repeating the Japanese experience, that those concerns have since been reduced, and that the stance of the Federal Reserve is one reason those concerns have been reduced. This does not mean that the Fed solved all our problems, and I never believed that it could. But I believe the Fed did avoid making our problems worse.
Posted by James Hamilton at July 2, 2011 10:59 AMdigg this | reddit
Two cheers for QE2.
And since there aren't a lot of good Hollywood movies out this summer, perhaps the Fed can treat us to "Son-of-QE2: Milton Strikes Back."
Posted by: 2slugbaits at July 2, 2011 01:00 PM
Yes, if the Fed didn't act to protect asset prices and increase the wealth of asset-holders, how would the asset-holders be able to fund the political campaigns to erode labor rights, reduce corporate taxes, and pass new trade agreements to ship even more jobs to low-wage foreign markets?
Posted by: Moopheus at July 2, 2011 02:08 PM
Was there really ever any doubt that pretending there existed >600 Billion more of savings than in fact exists could distort all kinds of prices?
Posted by: Bryce at July 2, 2011 08:16 PM
I've been meaning to offer mild criticism of the blogosphere's focus on the Fed and its monetary policy in recent times. (I'm one of those who think economics is a misnomer--it's political economy, an not calling it that is a highly ideological decision.) Anyway, here goes. Wish me luck!
I remain unconvinced by the arguments advanced by Duy, Thoma, DeLong, Krugman and others for more, bigger, better monetary easing to deal with the great recession. Perhaps I’m too Keynesian, (a concept which I always thought of as a serious skepticism regarding the efficacy of monetary policy in liquidity trap conditions with a depressed labor market.)
I think that these economists are still, often despite themselves, somewhat in thrall to the myth of the market according to which firms operate in competitive markets and are price-takers. I suspect this notion lurks behind their apparent confidence that additional QE on a large scale isn’t more likely to result in stagflation than in a major improvement in the outlook for employment and output. I don’t share that confidence. And even to the extent a prolonged, QE-aided expansion did eventuate, I’m of the opinion that job growth would be at the expense of real wages for many, and of a further increase in income inequality.
QE acts in part by lowering the cost of working capital. But how might (J. K.) ‘Galbraithian’ firms respond? They would aim to maintain prices and increase profit margins as the cost of funds declined. They might add capital equipment, but this has an ambiguous effect on total domestic employment, though German machinery manufacturers, say, might take on some more workers. These US firms would ‘sweat’ their physical assets and their existing workforces. But they’d be loath to add jobs or to lower prices, preferring to use productivity gains to boost profit margins.
US firms might use cheaper financing to increase the quantity of their imported inputs, but with a weaker dollar and with global demand-pull inflation affecting some markets (raw materials, some fuels, etc), they’d try to pass on these higher prices to American customers, and be willing to tolerate higher inventory to safeguard market share in the US, and/or focus sales efforts on the higher half of the income distribution, but leaving prices beyond the means of even an employed bottom third of the labor force. Meantime wages, salaries, and asset values for the top 20-30 percent would be booming as profit margins were increased, and prices were maintained or raised in the US. Keep in mind also how inelastic demand is for a range of goods and services.
What else might US companies do with more and cheaper money? Well, they might expand overseas. Manufacturers might outsource even more. Banks might lend those juicy newly created dollars to vicious oligarchies abroad even more eagerly than to the vicious American oligarchy.
So I foresee a substantial risk of a stagflationary outcome. Politically, too, I think it’s a mistake to hark on so much about what the Fed should be doing at this point. Economists should be denouncing Congress, deficit hawkery and hysteria, and the immoral lunacy of rightwing ideology on fiscal matters. Bernanke, QE3, etc are just a distraction at this point.
I know Krugman, DeLong, etc all do their bit in pointing out very strongly the need for a major fiscal policy response, and I heartily applaud their efforts. But the focus has been on monetary policy an awful lot of the time, and not enough in my view on the stagflation risk inherent in American capitalism. But I’m open to persuasion about this.
One problem, as I see it, with monetary policy in any case is in the types of assets the Fed buys in a QE program. I suggested an alternative on another blog, which I’ll share here for your edification and amusement:
Rather than have the Fed purchase government securities, would it not be far more effective for the Fed to purchase a lock of hair from each citizen in the lower half of the income distribution?
Ben Bernanke could make a live, nationally televised address, instructing folks whose household income is below the median to place locks of hair in ziplock bags and mail them with a photocopy of their Social Security card to the Federal Reserve. Upon receipt, a bunch of newly printed dollar bills would be mailed, with a request that the (tax-free) money be spent in the U.S.A.
Bernanke would repeat the process each quarter until the recovery was in full swing.
In place of hair, the completely bald could mail in a doctor's note affirming that the citizen was balder even than Milton Friedman.
I, for one, have no doubt that the economy would quickly move towards surging growth and full employment.
Posted by: stunney at July 2, 2011 09:00 PM
...and how many people did QE put back to work???
(Oh, it didn't put ANY back to work. It just juiced asset values of those already holding tremendous wealth.)
Posted by: Terry at July 3, 2011 04:22 AM
QE2 Was Too Small and Too Short
Clearly, Chairman Bernanke made the right move (no surprise) to prevent a double dip recession which many were expecting last summer, but just as clearly, he caved to political pressure from the right to avoid "debasing" the dollar.
Any Keynesian could tell you that interest rates are still far too high relative to the marginal efficiency of capital and that is why businesses are simply sitting on their cash hoards instead of investing in productive capacity and adding jobs. Mortgage rates in particular should be cut in half. The longer we ignore the obvious Keynesian principles, the longer we will be in this quagmire.
Posted by: Paul at July 3, 2011 06:41 AM
"...many of us were concerned last summer about the danger of the U.S. repeating the Japanese experience, that those concerns have since been reduced..."
Of course, you mean the horrific Japanese experience of 4.7% unemployment. No danger of that.
Posted by: jcb at July 3, 2011 07:07 AM
The point that the market priced in the effect deserves more emphasis. Conservatives, particularly those without much knowledge of economics, generally believe in markets and, to be specific, in a fairly strong version of efficient markets. It would contradict their own beliefs if the markets did not price the program in as soon as information was released about it, as soon as it became a real expectation. Yet they have made and assuredly will continue to make the argument that, look, see there is no effect, though that is absolutely contradictory of their own belief system. The only way there could be no effect is if markets don't price efficiently.
On a different note, it's interesting that we can evaluate this program with relative clarity because nothing much happened after it was firmly announced. The economy sort of continued, got a little better, got somewhat worse. Worries about demand continued. Worries about Greek default ebbed and swelled. There was no great shock to confuse the data.
Posted by: jonathan at July 3, 2011 07:19 AM
At best it appears from the graphs that QE2 achieved virtually nothing. The monetarists and Keynesians who see the world though a money demand side filter see renewed inflation as a positive while those who base their economics on supply side principles of real assets see this with concern as the price signals are once again distorted and unreliable.
Demand side economists see a declining dollar as some day, one day, hopefully soon stimulating increased exports while those looking at real assets see monetary policy hindering the purchase of critical foreign parts and sucking the value of savings away from the poor and those on fixed incomes.
Real interest rates are all over the map with a huge decline in anticipation of QE2 but then a large runup after QE2 when reality arrives. Then as 1st quarter growth does not live up to the predictions and 3% predictions turn into 2%interest rates decline and loan demand falls. At most QE2 has a transient effect on interest rates and that is not even clear.
And equities climb from the effects of inflation and the fact that interest rates are so low there is nowhere else for investors to put their money.
But perhaps most telling is that as of April 2011 Japan and the US are in almost the same position. It is true that Japan began their decline as a deflationary recession but to stay there they have lived by nearly the same fiscal policies as the US. More and more it is becoming clear that monetary policy has become ineffective, if it ever was, but Keynesian redistribution and tax fiscal policies are sucking any life out of a possible recovery.
Only when fiscal policy allows traders to once again generate a return on capital without state confication of profits will there be a recovery. It is as if the state constantly searches for any green shoot of recovery and promptly cuts it off.
Posted by: Ricardo at July 3, 2011 08:28 AM
Borrowing from J Taylor closing comments
"Milton Friedman’s and Anna Schwartz’s classic NBER study empirically evaluating
monetary policy during the Great Depression was not completed until thirty years after that
contraction was over"
And to honor M Feldstein leadership and contribution to NBER, may I invite readers to compare total credit to GDP 1929 and 2000 (private,corporate and public)
Further details are available through FRED consumption,private debts,banks non performing loans,comparisons with 1929 plenty abound.
Disturbing are the contradictions, a satisfaction about the new gained purchasing power of MBS and no questions asked on their worthiness.
D Wheelock has published a series of empirical data and interesting studies comparing two crisis
The Federal Response to Home Mortgage Distress:
Lessons from the Great Depression
David C. Wheelock
Comparing the Federal Reserve’s Responses to the Crises of 1929-1933 and 2007-2009
The prevalent scientific approach through the captioned conference,is for the least conspicuous.
Posted by: ppcm at July 3, 2011 08:36 AM
JDH Nice post, but what your graph doesn't show is what you mean by "bad equilibrium." Under certain assumptions "bad equilibrium" could mean simply stuck at a suboptimal point. But if you assume adaptive learning rather than rational expectations learning, then "bad equilibrium" could really mean no equilibrium, but rather a divergence threshold. Once you cross a path in the phase diagram the whole relationship between prices, output and interest rates becomes unstable and moves away from equilibrium. So you could have an unstable deflationary path. Of course, you can get the same kind of unstable path with positive inflation. I think it's the unstable path from "no equilibrium" that had the Fed really losing sleep at night more than just being locally stuck at a low equilibrium point.
Posted by: 2slugbaits at July 3, 2011 09:41 AM
Stephen Williamson of Washington St. Louis thinks QE can’t have any effect; it’s irrelevant. See:
I could never understand his explanation. To me printing billions in new money and buying long-term securities pushes out their demand curve and thus increases their price and so lowers their yield, at least in the short run. You do this enough you could push down long-term rates a lot and increase investment.
Do you understand what Williamson is saying? Perhaps you could explain it, why you think it’s right or wrong.
Posted by: Richard H. Serlin at July 3, 2011 09:53 AM
QE2 was perpetrated in the same vain as the economic propositions before it. Nothing has been learned. Expect more of the same.
Posted by: flow5 at July 3, 2011 10:34 AM
The only sort of quantitative easing that will move unemployment downward is the most old-fashioned and popular sort: citizens producing counterfeit bills.
Posted by: Will at July 3, 2011 01:07 PM
"Rather than have the Fed purchase government securities, would it not be far more effective for the Fed to purchase a lock of hair from each citizen in the lower half of the income distribution?"
Good God, there's even an argument for income redistribution to solve our problems. Seemed to have missed that one in my macro classes.
Posted by: Otto Maddox at July 3, 2011 01:55 PM
And how much did savers lose on the artificially low interest rates? No one wants to talk about that elephant in the room.
Posted by: jorod at July 3, 2011 03:06 PM
Re: the stagflation point. What exactly is that other than a political label? The single episode that existed was driven by 2 oil embargoes which pushed large amounts of resource cost inflation through the economic system. Other than those episodes, the 70's were not low growth. If you look at Carter's term only, the period so often cited as a form of dire warning, he had a year of higher growth than trend - higher than anything achieved under Reagan (whom I voted for instead of Carter). We never really had stagnation, but we did have inflation and that was caused mostly by the explosion in resource prices. Stagflation is word. It happens to have stuck and now it's used to justify all sorts of crap because every mention is meant to convey the sense that there's something terrible lurking in the bushes, that any economic agenda other than tax cutting leads to the mythic bogeyman stealing your children at night.
Posted by: jonathan at July 3, 2011 07:30 PM
"how much did savers lose on the artificially low interest rates? No one wants to talk about that elephant in the room."
Only one interest rate is low -- that on risk-free savings.
The spreads on other rates are very large, making other rates very high compared to the risk-free rate.
Moody's Baa corporate bond rate has been 5.95 points higher than the three-month T-bill rate so far this year. The 40-year average is 3.85 -- so this is 55% higher than the norm.
The 30-year conventional mortgage so far in 2011 has averged 4.71 over the three-month T-bill. From 1971 through 2010, the average was 3.38%.
So for all the Fed has done with mortgage securities, the spread is still 39% higher than the 40-year average.
Even state and local bonds -- government issued, mostly insured and very safe -- are yielding 4 points more than the historical average compared to T-bills.
There's a risk-reward relation in interest rates and investing. For persons who take *no* risk to get minimal reward (in an economy with 9% unemployment, while running 12% below capacity) is not at all upsetting to me.
Posted by: Jim Glass at July 3, 2011 10:49 PM
Ricard wrote in part about QEII,
"The monetarists and Keynesians who see the world though a money demand side filter see renewed inflation as a positive"
To set the record straight, no monetarist such as Friedman or Schwartz would have supported QEII. The only so called 'monetarists' that did support that policy are the Keynesian types who, albeit kicking and screaming that it hurt, accepted the overwhelming theories of the real monetarist which disproves many of the developing Keynesian monetary theory. But these people are still Keynesian at heart, never call them monetarist.
For the record, Friedman would have characterized TARP as clumsy, corrupt, and wasteful, but necessary to stop the modern equivalent of a severe bank run. But do not make the mistake of thinking quantitative easing is the same as monetary intervention to save the banking industry such as TARP. It is not. Friedman would describe QEII exactly as it turned out to be, an ineffective short term Phillips attempt, which caused more damage than good.
Posted by: Ed Hanson at July 4, 2011 06:54 AM
Ed Hanson: You might find this discussion of Friedman and QE of interest.
Posted by: JDH at July 4, 2011 07:40 AM
Ed Hanson: To set the record straight, no monetarist such as Friedman or Schwartz would have supported QEII.
Here are Milton Friedman's own words from 2000.
"The Bank of Japan’s argument is, “Oh well, we’ve got the interest rate down to zero; what more can we do?”
It’s very simple. They can buy long-term government securities, and they can keep buying them and providing high-powered money until the high powered money starts getting the economy in an expansion. What Japan needs is a more expansive domestic monetary policy."
What I find astounding is that the radical politicization of Chicago economists has gone as far as to deny the very existence of their own founder. It is like the erasure of purged opponents from photos of Stalin's era. It is as bizarre as a claim that the world is flat. It is a sad state when theological belief has replaced analytical reason.
Posted by: Joseph at July 4, 2011 09:06 AM
The chart of Wilshire 5000 Price Index (Full Cap) appears to be the inverse of the chart of the Nominal Broad Exchange-Weighted Trade Value of the US$ shifted by a few days.
That suggest to me that asset values essentially did not increase over the period examined. Rather, the price of those assets adjusted to reflect the value of the currency in which they were expressed.
In general and for all time, that is what happens anyway. This suggests to me that "asset values" are a poor measure of the success of QE2, and that the value of the US$ is damning testimony of the effect of QE2. The holders of assets of all kinds, from precious to base metals and equities were protected while the holders of cash were devoured.
Posted by: Jerome Barry at July 4, 2011 09:24 AM
Stagflation is better than the Japanese experience?
Posted by: Anonymous at July 4, 2011 11:47 AM
From the data it certainly seems as if QE2 had its desired effects and we’ve avoided a liquidity trap, but there are going to be consequences for this in the long run. Output growth is still very slow, and the growth of the money supply is out of proportion. This means, very simply, one thing: inflation. Businesses may have more money to expand, and banks may be lending again, and, yes, the economy is getting back on track. But while this is a victory, it isn’t one without a cost. At some point in the future, the price level is going to have to rise along with the money supply. At the same time, the continuing depreciation of the dollar (which will be faster when the inflation begins) will eventually hurt consumers further, as imports which are depended upon by a large percentage of the populace will become more expensive, which will drive down consumer demand. Once the recovery gets underway, and we are past the threat of a double dip recession (which I believe we are, thanks in no small part to QE2), it is imperative that the Fed pursue a contractionary monetary policy as to mitigate inflation. No doubt the Fed knows this, and will be working toward this goal; however, I think that is extremely important and bears restating. Additionally, with interest rates as low as they are, credit is being freed up and borrowers are regaining confidence. If the rate is kept too low, however, they may gain entirely too much confidence, and make unwise decisions. If that is allowed to happen, we could be in a whole new mess, all over again.
Posted by: Chris Forstrom at July 4, 2011 03:34 PM
Chris Forstrom Once the recovery gets underway, and we are past the threat of a double dip recession (which I believe we are, thanks in no small part to QE2), it is imperative that the Fed pursue a contractionary monetary policy as to mitigate inflation.
Wouldn't it make more sense to adopt contractionary fiscal policies rather than contractionary monetary policies after (and ONLY after) the recovery gets its feet firmly on the ground? The Fed should be the last actor to move away from an expansionary policy.
Posted by: 2slugbaits at July 4, 2011 04:26 PM
The Fed confused keeping the banks open with bailing them out, IMHO. They could have guaranteed all deposits to $100 million and even if there had been a run on the banks, would there have been inflation with our debt overhang? Is the Fed that scared of high-powered money in the hands of the people? They could have used the technical insolvency of some bad banks to clean house. The bondholders could have taken haircuts. We are waiting for the other valuation shoe to drop even now... and the derivatives are all off-balance sheet.
Instead, the Fed bailed out its Wall Street handlers in what Barry Ritholtz accurately refers to as the greatest wealth transfer from working folks to the wealthy in history.
To present the charts above as evidence of some sort of "success" is really sad.
Posted by: Benign at July 4, 2011 08:07 PM
I remember that clearly. And Friedman was right for the case of Japan at that time. Because the Central Bank of Japan had been making major mistakes for decades (much worse than even the US Fed). As Friedman points out, the bad policy finally reached the breaking point when began with a pathetic monetary policy to break its stock market and real estate bubbles. The Bank then spent another decade refusing to force its member banks to resolve its bad debts from the bubbles, and compounding all these errors by a monetary policy tighter than that which would resume normal money creation. Friedman never mentioned the other leg of Japan's difficulty, its government's refusal to lower marginal tax rates on persons and business; but I believe, since he saw no hope there, it left the only arrow in the quiver, creation of money by Central Bank action.
It is important to note, that Friedman only said that a policy of money creation would be better than what Japan had at the time, which was long term deflation. But he never said it would create a good economy. My words - years of stagflation would better than long term deflation. And do I need say, stagflation is not a good thing.
The reason that Friedman would not have recommended quantitative easing at this point of time in the US, is simply that US has not had decades of deflation yet. The more dynamic US has other means still to keep this period of deflation short term. He would recognize the change in direction coming to the legislative branch of government shown by the 2010 election. He would recognize that the 2012 election likely will change the executive branch. He would see some confirmation of this change by the extension of the current tax rates that occurred because of the 2010 election. In all the likelyhood of the US making decades of fiscal and monetary mistake as did Japan as small. And therefore, prudent and normal money creation would suffice.
Note: The mission that Milton Friedman felt in his last years of life would make interesting discussion. Among other things, he was pointing out new areas of monetary theory and approaches that he felt may improve the field.
Posted by: Ed Hanson at July 4, 2011 11:47 PM
Stagflation is better than the Japanese experience?
Is there really a difference?
Posted by: Ricardo at July 5, 2011 08:26 AM
"it is imperative that the Fed pursue a contractionary monetary policy as to mitigate inflation ... I think that is extremely important and bears restating."
What inflation? The market expectation of inflation over the next ten years is 1.73% and falling.
It is imperative to contract from that??
In the words of Hawtrey about all the warnings of the risk of imminent inflation during the Great Depression, this is like crying "Fire!" during Noah's flood.
Where does all this obsession with inflation come from?
Posted by: Jim Glass at July 5, 2011 04:03 PM
So the sum total evidentiary justification for QE is that the US's more aggressive QE resulted in 1-2% CPI whereas Japan's less aggressive QE resulted in deflation?
Seems like no justification at all to me, even if I believed that the greater scale of US QE was the reason for that difference (what about the bigger Japanese bubble that preceded its deflation, or the greater involvement of Japan in consumer electronics manufacturing, where prices naturally deflate, or Japan's being subject to greater manufacturing competition from China).
And not particularly consistent with your argument that QE isn't inflationary.
Posted by: Tom at July 6, 2011 03:46 PM