The mainstream media is beginning to size-up the results of QE2. And apparently it’s looking it was all a great big monetary non-event. This is what I said before QE2 even started, however, it looks like the damage has already been done. QE2 didn’t monetize anything. It didn’t cause the money supply to explode. It didn’t really do anything except cause a great deal of confusion and generate an enormous amount of speculation in financial markets that now appears to be contributing to turmoil and strife around the globe. But the misconceptions continue. This weekend the NY Times tells us tells us that QE2 was ineffective mainly because it wasn’t large enough:
“WASHINGTON "” The Federal Reserve's experimental effort to spur a recovery by purchasing vast quantities of federal debt has pumped up the stock market, reduced the cost of American exports and allowed companies to borrow money at lower interest rates.
But most Americans are not feeling the difference, in part because those benefits have been surprisingly small. The latest estimates from economists, in fact, suggest that the pace of recovery from the global financial crisis has flagged since November, when the Fed started buying $600 billion in Treasury securities to push private dollars into investments that create jobs.”
They’re right that QE2 has been a disappointment. And most certainly a monetary non-event, however, there is substantial evidence now showing that QE2′s one targeted goal – increasing inflation expectations – is working via the exact wrong channels by contributing to the surge in commodity prices. So while it’s been a monetary non-event it’s been a substantial economic event.
Where the NY Times and economists like Paul Krugman (who is now saying “told ya so” after supporting QE at much larger levels) get it woefully wrong is with regards to size. There has been a chorus of economists in recent weeks telling us that QE2′s results have been disappointing because it wasn’t large enough (they’re essentially backpedaling from previous assertions that QE2 would do something beneficial). And now that it’s becoming clear that QE2 didn’t contribute positively to economic growth these same economists are changing their tune to give the appearance that QE is not a flawed policy, but that it was merely implemented incorrectly. This is sheer nonsense.
When I first discussed QE last August and why it would not contribute positively to economic growth I described how QE was akin to an apple salesman who can’t sell enough apples. So, instead of altering price he merely alters the number of apples on the shelves. Altering reserve balances at banks is perfectly analogous. Giving the banks more reserves does nothing because banks are never reserve constrained. But now all of the experts are trying to convince us that QE just wasn’t tried hard enough! If only the apple salesman had put more apples on the shelves – then his sales would have improved! No, that’s not how monetary policy works. And as I’ve said for many many months now, this obsession with size is entirely misguided. QE2 isn’t about size. It is about price.
QE2 was destined to fail before it ever started. Not because it wasn’t large enough, but because rates can’t be controlled through size. They are controlled by targeting price. The Fed controls the short end of the curve by setting the rate. They do not come out at the FOMC meetings and declare that they will buy $XXXmm in reserves. They announce that the short rate is X.XX%.
With regards to QE2 the Fed has come out and said they are going to buy back a specific number of bonds. And the bond market has yawned at the Fed. In fact, the bond market has spat in their face. Long rates are higher by almost 100 bps since QE2 started and there is no evidence that QE2 is helping to spur the lending markets as the Fed might have hoped. Can you imagine if the Fed set the overnight rate at 0.25% and the market just ignored them and took short rates right up to 1.25%? The Fed would be mocked as a meaningless institution. But in the case of QE2 we make all sorts of excuses about size, real rates, etc in order to shield their impotence.
Had the Fed hoped to control long rates they should have come out and directly stated their target rate. They should have done exactly what they do at the short end – stand guard at that rate and challenge any and all speculators to move the rate. But my guess is they don’t want to do that because they are fearful it will be viewed as a mass monetization of debt (even though the Fed can do no such thing). That would spark a mass hysteria over inflation and could cause investors and speculators to pile into other assets and that might counteract the entire efforts of the Fed’s actions. Oh wait, that happened anyways.
The evidence is beginning to show that QE2 was a giant SNAFU. It was a misguided policy that was improperly implemented and entirely misinterpreted by the public (including 99% of all economists reporting on it). The US economy is in a worse position because of this policy. It’s time for the Fed to stop tinkering with experimental policies. And it’s not helpful when the same people who were wrong about this policy from the very beginning make excuses for the Fed that might only encourage them in the future. The US economy might look like a corpse, but that doesn’t mean it is ripe for Dr. Bernankenstein’s experiments….As I said 8 months ag0 – it’s time for Dr. Bernanke to put down the mallet and step away from the operating table.
Cullen,
Why does the dollar go down?
The U. S. economy is in a relative good shape (compared to others, housing and employment be damned). So it is not the economy.
Is it the fiscal policy or the monetary policy, or other misconception?
On a second question, to set the target rate, does the Fed not need to set it for the entire yield curve? That will be quite a spectacle.
The USD has essentially become a EUR inversion trade. The ECB is tight so the USD falls. It’s more complex than that, but the real move in the EUR higher developed earlier this year when the ECB started chatter about rate hikes. The Fed on the other hand appears on permanent hold so the TW USD is on the decline. It’s their loss really. In this environment the weak dollar will help enormously. They need the same thing (weak Euro) and they’ll likely get it when their economies weaken again.
That is a about reason. But I am not sure if that is how everyone else thinks. Look at silver. The rate differentiation can’t possibly explain silver’s move.
The public thinks dollar is toast. But whether they are wrong or not, as you said, silver can not be messed with.
If the dollar is toast you’re gonna need lead, not silver. Maybe some SWHC stock….
I know this is a little off-topic, but it seems Geithner does know how the US monetary system works: (In an interview) “Is there a risk that the United States could lose its AAA credit rating? Yes or no?”
Geithner’s response: “No risk of that.”
Reporter: “It’s enough to make you wonder: How could Geithner know this to be true?…He left no room for a trace of a possibility, ever.”
No insolvency risk. A no-bs answer. I am impressed.
http://economictimes.indiatimes.com/news/international-business/us-treasury-secretary-tim-geithner-downgrades-his-own-credibility-to-junk/articleshow/8077628.cms
Don’t be too impressed. This was the head regulator of the banks before & during the greatest bank crisis in US history. How he became tsy sec is mindboggling…
Your analysis is impeccable with regards to accuracy, but no one really seems to understand all of this. It makes me more concerned than anything else.
Cullen,
How can you keep saying that QE is a monetary non event!?
In my previous post, I have clearly explained to you why QE or money creation is inflationary but you keep beating the same drum.
Why can’t you just accept that your understanding is not correct?
This is becoming ridiculous.
Paul,
The only thing that is ridiculous here is that you still think the money supply has been altered. Please read this until it is burned into your soul. The facts don’t lie:
http://pragcap.com/the-exploding-u-s-money-supply-myth
Another reason for the "disappointing" effects of QE is this. In as far as QE has boosted the value of people's assets, it's the assets of the rich that have been boosted. And this won't have much effect because the rich do not alter their spending habits by much given a change in the value of their assets or income.
In as far as QE has made the assets of the rich more liquid than they would otherwise have chosen, there won't be much effect either, except that the rich can be expected to use their excess cash to buy other assets. Hence the stock market appreciation.
so the NYT says QE2 was ineffective because it wasn't large enough? Seems a description better directed towards fiscal policy….and still does. And to say the public isn’t feeling the benefit of QE2 is not only perpetuating the myth that it actually should have, but that it was simply another attempt at trickle down economics….pump up assets, make people feel warm & fuzzy wealth effects, start the credit engine….all the while oblivious to the idea that trickle down eco doesn’t work (except for the richest Americans, where it is pretty much focussed), and that the US economy and financial system in particular is still deleveraging from an almost existential moment.
The article’s concern about exit strategies is almost moot IMO. Happy to hear if I’m wrong, but functionally, paying IOR is accounting for the reserves in the same way (and pretty much same rate) that selling more SFP, or Bills, or offering deposits would. They’re not goin anywhere, we know banks don’t need reserves on hand in order to lend…..it’s almost like the US economy is detined for a pretty ordinary decade simply because polkicymakers have the wrong ideas about how the economy works, how interest rates work, and how incentives work.
Cheap dollars, meant to stimulate trade, drive up oil prices, slowing the global economy. We have no leadership. Just a bunch of knuckleheads in the weight room. NO PAIN… NO PAIN!.
People like Chris Dillow and JKH seem to suggest that QE increases deposits as well as reserves.
When the treasury spends from its account at the federal reserve, it increases both deposits and reserves of the banking system.
When I buy treasury bonds with cash, it increases both deposits and reserves of the previous bondholder.
When China buys treasury bonds with its dollars at the federal reserve, it increases both deposits and reserves of the banking system.
So why wouldn’t the Fed’s purchases of bonds also increase both deposits and reserves?
They’ve altered the term structure of savings. Where’s the beef? There has been no increase in the money supply. Only a portfolio rebalancing.
C’mom, don’t sugarcoat it–what do you really think about QE 2? :>) Seriously, your apple seller analogy is a pretty good one and is a great way to explain QE to the unfamiliar.
“QE2 was a giant SNAFU”. No, the SNAFU originated from the fiscal transfer payments (interest, pensions, defense spending, military and civil service pensions), & government back-stops (foodstamps, welfare, & unemployment benefits),the debt purchases (borrowed money & borrowed time), actually represented.
BT:
“So why wouldn't the Fed's purchases of bonds also increase both deposits and reserves?”
Open market operations should be divided into 2 separate classes (#1) purchases from & sales to, the commercial banks; & (#2) purchases from, and sales to, others than banks:
(#1) Transactions between the Reserve banks & the commercial banks directly affect the volume of bank reserves without bringing about any change in the money supply’s definition. The "trading desk" "credits the account of the clearing bank used by the primary dealer from whom the security is purchased". This alteration in the assets of the commercial banks (the banks' IORs), increases – by exactly the amount the government securities portfolio was decreased.
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