Brian P. Sack, head of the open market desk at the New York Fed, had some comforting words on Monday — for those expecting another bout of asset-pumping quantitative easing.
Speaking at the 2010 CFA Institute Fixed Income Management Conference in Newport Beach, California, Sack remarked:
In terms of the benefits, balance sheet expansion appears to push financial conditions in the right direction, in that it puts downward pressure on longer-term real interest rates and makes broader financial conditions more accommodative.
One can reach that judgment based on the empirical evidence from the earlier round of asset purchases, as mentioned before. In addition, the market responses to more recent news about the balance sheet also lean in this direction. The market response to the reinvestment decision at the August FOMC meeting seemed largely in line with the estimated effects from the earlier round of asset purchases, once we account for the size of the surprise and the anticipatory pricing that occurred ahead of its announcement. And the increased expectations for balance sheet expansion in response to the September FOMC statement also generated a sizable market response.
To be sure, I think it is fair to say that this is an imperfect policy tool. Even under the estimates noted earlier, the Federal Reserve had to increase its securities holdings considerably to induce the estimated 50 basis point response of longer-term rates. In addition, there is a large degree of uncertainty surrounding the estimates of these effects, given our limited experience with this instrument. Lastly, it is reasonable to assume that the effects of balance sheet expansion would diminish at some point, especially if yields were to move to extremely low levels. Nevertheless, the tool appears to be working, and it is not clear that we have yet reached a point of diminishing effects.
Some observers have argued that balance sheet changes, even if they influence longer-term interest rates, will not affect the economy because the transmission mechanism is broken. This point is overstated in my view. It is true that certain aspects of the transmission mechanism are clogged because of the credit constraints facing some households and businesses, and it is true that monetary policy cannot directly target those parties that are the most constrained.
Nevertheless, balance sheet policy can still lower longer-term borrowing costs for many households and businesses, and it adds to household wealth by keeping asset prices higher than they otherwise would be. It seems highly unlikely that the economy is completely insensitive to borrowing costs and wealth, or to other changes in broad financial conditions.
Sack would be an expert on market transmission. As Manager of the System Open Market Account for the FOMC, he’s basically the contact point between monetary policy and financial markets.
Anyway, those market reactions — in pics since August:
Fed chairman Ben Bernanke seems to be, incidentally and unsurprisingly, largely of the same opinion as Sack.
Related links:
A psy-QE-logical problem - FT Alphaville
Stop the market – the Fed wants to get off – FT Alphaville
Quixotic QEasing - FT Alphaville