We’ll be back later with a proper preview of next week’s FOMC meeting, but for now here is something to argue about:
1. QE1 was more effective than QE2.
2. It is easier to find and quantify QE’s effect on Treasury yields than to identify and measure QE’s effect on real economic performance.
3. QE also lowered nominal interest rates on agencies, MBS, and corporate bonds, with magnitudes differing across bond types and maturities.
Those are the three conclusions drawn by Credit Suisse economists after reading through a number of papers on the efficacy of the Fed’s first two rounds of QE and its impact on a number of related variables. It’s early days yet and there will be many, many more studies about this in the years to come.
We’ve written a lot about this before and won’t belabor the point, but we’ve always found it a bit strange to judge quantitative easing in terms of its impact on nominal yields. We had this debate back in 2010 in the months after QE2 was announced. Treasury yields first fell in anticipation of the move (after it was telegraphed at Jackson Hole) but then stared climbing in the weeks following the start of the program itself. This led to a bunch of nonsensical headlines about how QE2 had failed.
And as we said then, the goal of quantitative easing was never to lower nominal treasury yields but to lower expected real yields by raising inflation expectations.
But even that wasn’t the ultimate goal of the policy, which was more simply to stem disininflation and lower unemployment — in other words, to satisfy the Fed’s dual mandate. Here is how the Credit Suisse summarise the evidence on these metrics (our emphasis):
Research dedicated to the effects of LSAP on GDP and employment is limited, but they do generally find these programs to be effective at promoting GDP growth, though to different extents.
One study (Fuhrer and Olivei, 2011) found that $600bn Treasury purchases would increase real GDP by about 40-120bps while another study (Chen et al., 2011) suggested that the effects on GDP growth are not very likely to exceed 50bps. By using Okun’s law, the Fuhrer and Olivei study also theorized that the unemployment rate would drop by 30-45bps.
It should be noted that the estimated (as opposed to observed) effects on GDP and the unemployment rate are more gradual, usually taking place over the course of about two years.
The unconventional measures were generally seen as effective in preventing deflation at the zero lower bound through the signaling effect. However, economists do have contrasting opinions on the magnitude of QE’s price impact.
One study (Krishnamurthy and Vissing-Jorgensen, 2011) found that QE1 increased 10-year expected inflation by 96-146bps and that QE2 raised it by 5-16bps. On the flip side, one study (Chen et al., 2011) concluded that the inflationary consequences of QE1 and QE2 were less than 50bps. The Federal Reserve Bank of New York noted that inflation actually trended lower over the period when QE1 was in progress, though it probably fellless than it would have done without the asset purchases.
In a sense, QE2 “worked” for a little while as inflation and inflation expectations started rising and the economy appeared to rebound. Of course, the effect had faded by the following summer.
The reasons it faded are varied and probably impossible to untangle — in early 2011 the economy had to deal with the supply chain disruption from the Japanese earthquake, a commodity price spike throughout the Arab spring, the government nearly shutting down over an idiotic budget standoff, the perpetual European near-catastrophe, and of course there were those seasonality adjustment issues.
But it’s not unreasonable to think that a contributing factor was that the Fed’s commitment to further easing in a time of higher inflation, even with the unemployment rate still elevated, was no longer credible. We’ve long found it persuasive that the potency of QE2 in particular came as much from the signal it sent as from the direct inflation of asset prices or the size of the purchases.
Over the weekend, San Francisco Fed president John Williams touched on this idea in his interview with Robin Harding when he mentioned the idea of “open-ended” quantitative easing (see also Tim Duy). That is, the idea that the amount of assets purchased and the end-date for the program shouldn’t be pre-announced, but rather should be tied to specific economic results.
And as for whether QE3 would be effective, this is all before we get into issues of monetary policy in liquidity traps, potential market disruptions and other such complications. But we’ll leave that alone for now.
All of which is just to say that there’s a limit to how much can be extrapolated from the conclusions in these studies. But for those who want to take a closer look for themselves, we’re copying and pasting them from the Credit Suisse note:
Chen, Han, Cúrdia, Vasco, and Ferrero, Andrea (2011). “The Macroeconomic Effects of Large-Scale Asset Purchase Programs,” Federal Reserve Bank of New York Staff Reports, N0. 527. http://www.newyorkfed.org/research/staff_reports/sr527.pdf
Christensen, Jens and Rudebusch, Glenn (2012). “The Response of Interest Rates to U.S. and U.K. Quantitative Easing”, Federal Reserve Bank of San Francisco Working PaperSeries, 2012-06. http://www.frbsf.org/publications/economics/papers/2012/wp12-06bk.pdf
D’Amico, Stefania and King, Thomas (2010). “Flow and Stock Effects of Large-ScaleTreasury Purchases,“ Federal Reserve Finance and Economics Discussion Series, 2010-52. http://www.federalreserve.gov/pubs/feds/2010/201052/201052pap.pdf
Farmer, Roger (2012). “The effect of conventional and unconventional monetary policyrules on inflation expectations: theory and evidence”, NBER Working Paper, No. 18007.http://www.rogerfarmer.com/NewWeb/PdfFiles/Monetary%20Policy%20Rules_R.pdf
Fuhrer, Jeffrey and Olivei, Giovanni (2011). “The Estimated Macroeconomic Effects of theFederal Reserve’s Large-Scale Treasury Purchase Program”, Federal Reserve Bank of Boston Public Policy Briefs, No.11-2.http://www.bos.frb.org/economic/ppb/2011/ppb112.pdf
Gagnon, Joseph, Matthew, Raskin, Remasche, Julie and Sack, Brian (2010). “Large-ScaleAsset Purchases by the Federal Reserve: Did They Work?” Federal Reserve Bank of NewYork Staff Report, No. 441. http://www.ny.frb.org/research/staff_reports/sr441.pdf
Glick, Reuven and Leduc, Sylvain (2011). “Are Large-Scale Asset Purchases Fueling theRise in Commodity Prices?” Federal Reserve Bank of San Francisco Economic Letter,2011-10 http://www.frbsf.org/publications/economics/letter/2011/el2011-10.html
Hamilton, James and Wu, Jing (2011). “The Effectiveness Of Alternative Monetary PolicyTools In A Zero Lower Bound Environment,” NBER Working Paper, No. 16956.http://dss.ucsd.edu/~jhamilto/zlb.pdf
Krogstrup, Signe, Reynard, Samuel and Sutter, Barbara (2012). “Liquidity Effects ofQuantitative Easing on Long-Term Interest Rates,” Swiss National Bank Working Papers, No. 2012-2. http://www.snb.ch/n/mmr/reference/working_paper_2012_02/source/working_paper_2012_02.n.pdf
Krishnamurthy, Arvind and Vissing-Jorgensen, Annettte (2011). “The Effect of QuantitativeEasing on Interest Rates: Channels and Implications for Policy”, NBER Working Paper, No.17555. http://www.tilburguniversity.edu/about-tilburg-university/schools/economics-andmanagement/news/seminars/finance/2011/Vissing.pdf
Lockhart, Dennis (2012). “ Monetary Policy Limits: Federal Reserve Actions and Tools,” Federal Reserve Bank of Atlanta, speech at Institute of Regulation & Risk, North Asia,Tokyo, Japan, May 21, 2012. http://www.frbatlanta.org/documents/news/speeches/120521_lockhart.pdf
Neely, Christopher (2010), “The Large Scale Asset Purchases Had Large International Effects,” Federal Reserve Bank of St. Louis Working Papers, 2010-018D. http://research.stlouisfed.org/wp/2010/2010-018.pdf
Stroebel, Johannes and Taylor, John, “Estimated Impact of the Fed’s Mortgage-BackedSecurities Purchase Program,” forthcoming, International Journal of Central Banking.http://www.stanford.edu/~stroebel/MBS%20Purchase%20Program%20%20Stroebel%20and%20Taylor.pdf
Swanson, Eric (2011),“Let’s Twist Again: A High-Frequency Event-Study Analysis of Operation Twist and Its Implications for QE2,” Federal Reserve Bank of San Francisco Working Paper Series, 2011-08 http://www.frbsf.org/publications/economics/papers/2011/wp11-08bk.pdf
Swanson, Eric and Alon, Titan (2011). “Operation Twist and the Effect of Large-ScaleAsset Purchases,” Federal Reserve Bank of San Francisco Economic Letter, 2011-13.http://www.frbsf.org/publications/economics/letter/2011/el2011-13.html
Thornton, Daniel (2009). “The Effect of the Fed’s Purchase of Long-Term Treasuries onthe Yield Curve”, Federal Reserve Bank of St. Louis Economic Synopses, No. 25.http://research.stlouisfed.org/publications/es/09/ES0925.pdf
Thornton, Daniel (2012). “Quantitative Easing and Money Growth: Potential for HigherInflation?”, Federal Reserve Bank of St. Louis Economic Synopses, No. 4. http://research.stlouisfed.org/publications/es/12/ES_2012-02-03.pdf