Policymakers who favored QE2 are under attack from various directions right now, from other countries accusing the Fed of manipulating the dollar to domestic politicos to right-leaning economists.
Two of these QE2 advocates — NY Fed president William Dudley and San Francisco Fed executive VP John Williams — have just taken to the air waves and given a speech each in defense of the Fed’s recent decision.
Excerpts from the two below, then we’ll add our own comments.
Dudley first, with emphasis ours, from an interview with CNBC:
Well, it’s special because we’re at the zero bound in terms of short term interest rates. The reason why we’re moving to this policy is because we can’t lower short term interest rates any further. But– if you think about this conceptually, it really does the same thing as lowering short term interest rates.
When U.S. lowers short term interest rates, it affects long term bond yields– which makes financial conditions more accommodative. When we purchase large– when we do a large scale asset purchase by removing duration from the private market, we reduce long term bond yields so we have the same– consequence. …
You know, I think there’s sorta two sort of critiques of the large scale asset purchase program. One, it won’t be effective. It doesn’t do that much. And– and we agree with that, that we don’t think that this large scale asset purchase program’s going to have a huge, powerful effect on– on the U.S. economy.
And two, I think there’s a lotta concern about exit. Once– when the time comes and the U.S. economy finally does pick up speed and inflation starts to rise, will we– will we be– will–will– will we be able to exit from this program smoothly without a long term inflation problem? And I think the answer to that second question is really critical. And our answer to that question is very much yes. We have the ability to exit smoothly because we have the ability to pay interest on excess reserves.
Now Williams, from a speech Monday:
By way of background, it’s important to understand that by law Congress has charged the Fed with two objectives: maximum employment and price stability. Currently, the Fed is falling short on both counts. Unemployment obviously is unacceptably high. And, as I’ve explained, inflation is somewhat below the level that is consistent over the long run with stable prices. In other words, the Fed would like to kick the recovery into a higher gear and nudge inflation up a bit, avoiding further disinflation.
The Fed’s traditional policy tool is the federal funds rate, which is the overnight interest rate banks charge each other for loans. We’ve had our federal funds target set near zero for almost two years now and obviously that’s as low as it can go. So, to provide additional stimulus to the economy, we’ve used unconventional policy tools, most notably beginning nearly two years ago a program to purchase up to $1.75 trillion in Treasury securities and agency mortgage-backed securities and debt. This program has helped push down mortgage and other long-term interest rates, thereby supporting the housing market and the economy overall at a time when it desperately needed a boost. The Fed’s latest program involves purchases of a further $600 billion of longer-term Treasury securities, which will be carried out at a pace of about $75 billion per month. The idea is the same as before–to push medium and longer-term interest rates down further, giving added support to economic activity. So far, the responses in financial markets show that this program is working.
Except when they don’t show this. As the FT reports this morning, yields on the 10-year have been climbing sharply since the announcement:
And as PragCap notes, yields on the 5-year and, especially, the 30-year are also higher than they before Bernanke’s Jackson Hole speech.
Markets are complicated beasts, and as the FT notes, it’s possible that treasuries were simply overbought in anticipation of a bigger move by the Fed, which would make this an expected correction. In other words, you can still make the argument that yields would be still higher if the Fed hadn’t embarked on QE at all.
But it still doesn’t help the Fed’s case that yields (and now equities) are going in the opposite direction from the one they’d intended.
As to Williams’s point about the Fed’s dual mandate, it’s curious that more defenders of quantitative easing don’t mention this. Core inflation, after all, remains well below the Fed’s implicit 2 per cent target. Even if you think, as Jeffrey Lacker does, that the Fed shouldn’t pursue unemployment goals if it means risking runaway inflation, it still holds that the Fed right now is not delivering on either of its mandates.
Remember that it isn’t just long-term nominal rates that matter, but expected real rates. This was the point behind the research we recently covered that highlighted the importance of managing inflation expectations when short-term rates are at the zero lower bound.
At any rate, we (specifically this correspondent) continue to emphasise that we don’t know anything about anything, least of all whether QE2 is a good or a bad idea. We’re just trying to understand this from all sides, so feel free to set us straight in the comments.
UPDATE: Janet Yellen, the Fed Board of Governor’s new vice chair, also stepped up to defend QE2 in an interview with the Wall Street Journal.
Related links:
FOMC, minutes and minutiae – FT Alphaville
When strange things happen at the zero lower bound – FT Alphaville
FOMC composition and future monetary policy – FT Alphaville
It’s a QE2 backlash, doncha know – FT Alphaville
It’s a QE2 backlash, doncha know – continued – FT Alphaville