I say “sort of” because it was obviously too little, too late. But it’s now pretty clear that it did have an expansionary impact on both nominal and real aggregates. Let’s start with the “did it happen” question. Here’s Arnold Kling:
In the current setting, it appears that economic activity is expanding and inflation is higher than it had been. One may choose to interpret this as resulting from the Fed’s quantitative easing. However, I am not signing onto that one. I recall reading recently that QE 2 was basically canceled out by offsetting changes in Treasury funding operations. That is, as the Fed bought more long-term bonds, the Treasury issued more long-term bonds relative to short-term securities. So we are left with the channel that the Fed announced a higher intended path for nominal GDP, and this was self-fulfilling. Strikes me as a very difficult proposition to prove or disprove.
I also recall reading that QE2 was cancelled out, but as the following graph shows the base is up $300 billion since November:
Of course switching long and short term bonds does almost nothing (this was once called operation twist.) QE is all about increasing the base.
As far as the effects being “difficult to prove,” nothing could be further from the truth. Asset markets of all kinds responded very strongly to Fed rumors of QE2 in September and October 2010. Those sorts of event studies aren’t proof, but they’re the closest we get in macro—far more significant than most econometric studies published in elite journals.
I’m constantly surprised by people’s reluctance to accept the efficacy of monetary stimulus. When a (fiat) central bank is bound and determined to raise NGDP, it will never fail.
Everyone from Jim Hamilton to Paul Krugman to Martin Feldstein is talking about the recent acceleration of growth. But when I suggested this was evidence that QE2 might be working, Mark Thoma insisted that this couldn’t be true, as modern macroeconomics has established that monetary policy operates with significant lags. My initial reaction was “that’s what’s wrong with modern macro.”
Yes, I’m out of the mainstream. But it’s hard to find a more mainstream economist than Martin Feldstein, and he insists that QE2 is responsible for the recent upswing. We had a huge stock market rally triggered by rumors of QE2, and then in 2010:4 we saw the most rapid growth in real final sales in more than 2 decades. (Nominal final sales was also very strong, and is actually the better indicator–but everyone else seems to want to look at real variables. Note the focus on weak real GDP in the UK during Q4.)
In fact, Feldstein underplays the impact of QE2, as he only considers the impact of higher wealth on consumption. But the increase in asset prices produced by QE2 also raises investment. The depreciation of the dollar caused by QE2 raises exports. Indeed if QE2 produces economic growth, it also slightly reduces cutbacks of state and local government spending. BTW, it’s now obvious that S&L spending is so endogenous that it might as well be lumped in with the private sector, not treated as a sort of “fiscal policy” that can be waved around like a magic wand.
In addition, Feldstein actually underestimates the evidence in favor of QE2 being the cause of the recent acceleration in growth. It’s not just that stocks rose at roughly the same time. As I already noted, stocks clearly were rising in response to specific rumors of QE2 in September and October 2010.
In Kling’s post it’s a bit hard to figure out whether he is skeptical that monetary stimulus can boost nominal variables, or real variables. He provides this quotation from a Reinhart and Reinhart paper:
Second, changes in monetary policy can only change real interest rates temporarily.
Yes, some people argue that real interest rates are an important transmission mechanism. I doubt they matter much, but even if they did, note that 5 year TIPS yields have fallen into negative territory. In my view monetary policy works by raising expected future NGDP, and current asset prices. Kling then argues:
The point of the Reinhart and Reinhart paper is to demonstrate empirically that central bankers can only make a big difference if they make really big policy changes.
The important difference isn’t between big and small changes, but between temporary and permanent effects. We know (from asset market responses) that even quarter point changes in the fed funds target can have a huge impact on the stock market. These big effects occur precisely when the policy shocks lead to a change in the expected future path of policy. When they don’t, they have little effect.
In the first Kling quotation I provided he expresses skepticism about merely psychological aspects of Fed policy. In fact, we know that expectations are far more important than actual changes. I’ll finish with a couple easy thought experiments that demonstrate why expected future policy matters:
1. The central banks doubles the monetary base, and the change is expected to be permanent. Assume it occurred because a new populist government takes power in Bolivia.
2. The Fed doubles the monetary base right before Y2K hits, and announces that the money will be withdrawn from circulation 4 weeks later. Their intention is to make sure enough liquidity is available in case ATM machines break down on 1/1/00.
In case 1, nominal asset prices double, in case 2 they hardly budge. Yet in both cases the monetary base doubles. Why the difference? Purely psychological factors; different expectations about future monetary policy.
Case 2 is sort of like what happened in the 2008 crisis. In this case the Fed could leave this extra money in circulation for quite some time, because of a combination of IOR and near zero rates. But if Bernanke announced that the Fed was going to permanently abandon IOR, and planned to leave the base at twice its normal level even when T-bill yields rose back up to normal levels, inflation would explode almost immediately.
Commenters: I beg you not to ask me one more time to explain in a “mechanical” way how QE2 causes NGDP to rise. Hint: it has nothing to do with banks.
PS. Just to be clear, I am not expecting miracles from QE2. At the time I guesstimated that the markets had raised their 2011 NGDP growth forecasts from about 3.5% to 4.0% in the dog days of summer, to about 5.0% to 5.5% after QE2 was announced in early November. I still think we are in that ballpark, but obviously a collapse of the House of Saud or another euro crisis would shake things up. I’d still like to see about twice the monetary stimulus that we got, even though (paradoxically) I think we are gradually transitioning from an aggregate demand shortfall to an aggregate supply shortfall. But I continue to believe that more AD would boost the supply-side of the economy, mostly by speeding the removal of 99 week UI.
PPS. And no, $1200 billion in QE would not have provided “twice the stimulus.” It’s all about expectations.
Tags: QE 2