Archive for the Category Quantitative Easing

 
 

Beckworth interviews Hamilton

David Beckworth recently interviewed Jim Hamilton on a wide variety of topics, including energy and monetary policy.  At one point they discussed Hamilton’s recent research on the impact of QE.  Hamilton discussed the March 18, 2009 QE announcement, which is sometimes cited as evidence that QE was effective.  On the day of the announcement, 10-year bond yields plunged from roughly 3.0% to 2.5%.

Hamilton pointed out that the market response doesn’t necessarily indicate that rates fell due to monetary expansion.  An alternative interpretation is that the announcement led traders to re-evaluate their view of the economy, perceiving the Fed to have relevant non-public information. Hamilton suggested that investors may have thought:

What do they know that I didn’t?  And, maybe the economy is in worse shape than I thought.

If that were the case, then you’d expect other markets to reflect this bearish perception.  In fact, exactly the opposite occurred.  Here is the NYT, from March 18, 2009:

The Federal Reserve sharply stepped up its efforts to bolster the economy on Wednesday, announcing that it would pump an extra $1 trillion into the financial system by purchasing Treasury bonds and mortgage securities. . . .

Investors responded with surprise and enthusiasm. The Dow Jones industrial average, which had been down about 50 points just before the announcement, jumped immediately and ended the day up almost 91 points at 7,486.58. Yields on long-term Treasury bonds dropped markedly, and analysts predicted that interest rates on fixed-rate mortgages would soon drop below 5 percent.

This suggests that markets treated the QE announcement as an expansionary monetary policy, which sharply lowered long term bond yields and also raised equity prices by roughly 2%.

On the other hand, I do agree with Hamilton’s claim that the big decline in interest rates (throughout the world) during the Great Recession was mostly due to other factors such as slow growth, not QE.

PS.  Let me reiterate that QE is not a policy, it’s a tool.  Thus QE is not the way to prevent demand shortfalls.  To do that you need a sound monetary policy, preferably NGDPLT.  Then QE can be used as a tool to implement that policy, in the unlikely event it is needed.

David Beckworth interviews Joe Gagnon

Joe Gagnon is a former Fed economist now located at the Peterson Institute in Washington.  He’s also arguably the world’s leading expert on QE. The conversation with David was excellent from beginning to end.

Here are a few highlights (from memory):

1.  Gagnon’s research suggested that QE was somewhat effective at lowering long-term interest rates.  That’s also the consensus view of dozens of other studies he looked at.  He suggested that QE probably led to higher bond yields in the long run, which reflected the higher nominal growth of countries that engaged in more aggressive monetary stimulus.  He seemed to suggest this was a rather surprising result, but I think it’s in line with the previous views of monetarists like Milton Friedman.

2.  Gagnon likes NGDP targeting, and is somewhat split between growth rate and level targeting.  At one point he seemed to suggest an option somewhere between those two extremes.  I’d guess that reflects the behavior of the economy after 2007, when (in retrospect) a continued 5% NGDP growth rate might seem a bit too aggressive.

3.  He suggested that the Fed may have been held back around 2009-10 from doing even more QE by a fear of the unknown.  It was a new and untried policy instrument.  Gagnon also indicated that (in retrospect) it probably would have been better to do all three or four QEs right up front.  (I’m glad he said 3 or 4, as I’ve always been a bit unclear as to whether the first QE was in late 2008, or March 2009. It seems the leading expert also views the number of QEs as ambiguous.  The official number was three, but it seems like there were four.)

4.  David asked him about the options for monetary policy that he came up with as a researcher at the Fed during 2008-09.  I kind of regret not hearing him talk about whether the Fed looked at the options for Japan that were outlined in Bernanke’s 2003 paper.  There’s been a lot of criticism (from me and others) of the fact that Bernanke’s Fed did not pursue some of the more aggressive options that Bernanke recommended to the BOJ, in his famous paper that discussed the need for “Rooseveltian resolve.”  (Here I’m especially thinking of price level targeting.)  That’s not to say there are not good answers.  Bernanke got in hot water in 2010 for suggesting we needed to raise the inflation rate (to 2%).  If he had indicated a need to raise it to 3% or 4% to catch up to the trend line, the policy would have been even more controversial.

5.  Gagnon gave an excellent summary of recent events in Japan.  His view is similar to mine, but he’s followed things more closely and has much more knowledge of the situation.  The original Abe/Kuroda push for 2% inflation was partially successful.  Core inflation expectation quickly rose by about 200 basis points, from minus 0.75% to 1.25%.  They needed one final push, and in early 2016 tried to do so using negative IOR.  Unfortunately, the negative rate was only 0.1%, which was too little to have much effect.  Even worse, there was a political backlash.  That led the markets to lose confidence in the BOJ, and since then the yen has soared in value.  Thus inflation expectations are now coming down.  In retrospect, they would have been better off doing more QE.  Gagnon even suggested buying equities as an option.  He thought it was really important that the BOJ hit its 2% inflation target, and I agree.  That’s not because I favor inflation targeting (I don’t) but rather because I think it’s really important for central banks to hit their targets, for credibility reasons.  Unfortunately, it appears the Abe government has lost interest in this policy target.

6.  Gagnon pointed out that before the Great Recession most economists thought that a 2% inflation target would be enough to keep us away from the zero bound.  He also noted that early discussions of the pros and cons of a higher inflation target took account of the likelihood of hitting the zero bound.  Then Gagnon said something to the effect; “Well, we now know something new”.  We know that the zero bound problem can occur with a 2% inflation target.  So if economists thought that 2% inflation target was optimal for the US, then that can’t possibly be the case now.  Speaking for myself, I’m disappointed that so few economists are forcefully explaining why this new information suggests that we need a new target.  And it does not have to be 3% or 4% inflation, it could be NGDPLT.  But clearly some change is required.  And yet as far as I can see the Fed seems determined to continue muddling along with a 2% inflation target, which makes their “conventional” policy tool (interest rate targeting) almost useless going forward.

7.  Gagnon also did an excellent job explaining the problems with helicopter drops–it’s too effective if expected to be permanent.

 

Negative IOR need not hurt bank profits, if done correctly

The ECB moved more aggressively than expected to cut IOR and increase QE. Today I will explore the effects, beginning with the banks.  Recall how negative IOR was supposed to be so bad for bank profits.  It seems those theories were wrong:

Banks have warned that negative interest rates are eroding their profitability. The rates cut into banks’ net interest margins as lenders have been reluctant to pass on the cost of negative rates to all but the biggest retail customers.

To offset some of the pain to banks, the ECB will provide cheap loans through targeted longer-term refinancing operations, each with a maturity of four years, starting in June 2016. These loans could potentially be provided at rates as low as minus 0.4 per cent, in effect paying banks to borrow money. Banks will also benefit from a refinancing rate of 0 per cent.

Shares in eurozone banks rallied sharply after the ECB announcement with Deutsche Bank up 6.5 per cent, Commerzbank up 4.9 per cent, Société Générale up 5.4 per cent and UniCredit up 8.2 per cent.

Over the years I’ve pointed out that there are things that central banks could do to offset the hit to bank profits. For instance, they could raise IOR on infra-marginal reserve holdings, while they lowered IOR at the margin. I did not propose the exact offset discussed above, but it seems that the general concept is workable. Negative IOR need not be a problem for banks, if done correctly.

European stocks rose sharply on the more aggressive than expected announcement and the euro fell in the forex markets. Oddly, however, for the 347th consecutive time the “beggar-thy-neighbor” theory was falsified by the market reaction.  Not only did Europe’s actions not hurt the US, our stocks soared higher on the news:

Dow futures added more than 150 points after the ECB cut the deposit rate to negative 0.4 percent from minus 0.3 percent, charging banks more to keep their money with the central bank. The refinancing rate was also cut, down 5 basis points to 0.00 percent.

I warned people to be careful after the Japan announcement; the EMH is not a theory to be trifled with.  As you recall, Japanese stocks soared and the yen fall sharply when negative IOR was announced in Japan.  But then a few days later both markets went into reverse (probably for unrelated reasons).  Many people assumed it was a delayed reaction to the negative IOR.  That’s possible, but markets generally respond immediately to news.  With the European moves today we see yet another confirmation of market monetarism:

1.  Policy is not ineffective at the zero bound.  So do more!!

2.  Reducing the demand for the medium of account (negative IOR) is expansionary.

3.  Increasing in the supply of the medium of account (QE) is expansionary.  I.e. the supply and demand theory is true.

4.  There is no beggar-thy-neighbor effect from monetary stimulus.

Market monetarists were the first to propose negative IOR.  It’s our idea.  When your ideas are correct, they help to explain how the world evolves over time. Things make sense.  In contrast, people with a more “finance view” of monetary policy have been consistently caught flat-footed.  Note that these people are represented on both the right and the left, and they have been consistently wrong in their views of monetary policy at the zero bound.

BTW, James Alexander has a post showing that eurozone growth has nearly caught up with the US:

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Notice that at the beginning of 2012, NGDP growth in Europe had been running at less than 1% over the previous 12 months.  That’s the horrific situation that Draghi inherited from Trichet.  Draghi did move much too slowly at first, but at least things are beginning to look a bit better for the eurozone.  Still, Draghi needs to do more, as the eurozone is likely to fall short of its 1.9% inflation target.

Even better, the ECB needs to change its target, and set a new one high enough so that the markets are not expecting near-zero interest rates for the rest of the 21st century:

Take overnight interest rate swaps. They imply European Central Bank policy rates won’t get back above 0.5 percent for around 13 years and aren’t even expected to be much above 1 percent for at least 60 years.

Update:  The euro later reversed its fall.  But note that US stocks soared even after the initial plunge in the euro.  It’s interesting to think about why the euro reversed its losses–perhaps a view that the ECB action will make the Fed less likely to raise rates?  Or because it was expected that the action would lead to stronger eurozone growth?  What do you think?

Update#2:  Commenters HL and GF pointed out that the euro rose in value after Draghi indicated (in a press conference) that the ECB would probably not push rates any lower.

QE is not a policy, it’s a tool

Tyler Cowen recently linked to a post by Gerard MacDonell on QE:

Last month’s Press Release from the FOMC announcing the first rate hike in a decade contained a seemingly-innocuous and yet telling discussion of the interaction between interest rate and balance sheet policy.  It marked the end of false confidence in the efficacy of quantitative ease (QE), which can be traced to a technical error Ben Bernanke made while lecturing the Japanese on deflation in 1999.

The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run.

…The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way.

The passages above were not a major departure or surprise to the markets, but they confirm that the Fed leadership has now abandoned its original story about how QE affects the economy and has conceded that the tool is weak.  If QE were strong, the balance sheet could not remain large even as the Fed promised to raise rates only gradually.

It has long been obvious that QE operated mainly through signaling and confidence channels, which wore off on their own without any adjustment in the size or composition of the Fed’s balance sheet. Accordingly, QE cannot be relied upon to provide much help in the next economic downturn, which means the Fed will have to tread carefully to avoid a return to the zero bound.

There’s a lot of confusion about QE, mostly because there’s a lot of confusion about virtually every aspect of monetary policy; including the most very basic aspects, such as what is it, and how we measure it.

At one level QE is nothing new, it’s just changing the monetary base to impact the macroeconomy—what the Fed has been doing for many decades.  With QE, the Fed also says that they are changing the base in order to affect interest rates on Treasury securities.  But that’s also exactly what the Fed has been doing for many decades.  And for many decades the impact of monetary shocks on long-term interest rates has been ambiguous.  So that’s also nothing new.

And monetary policy has always been 1% about concrete actions and 99% about signaling.  That’s also nothing new.  So basically the argument that QE does not work is almost no different from the argument that monetary policy doesn’t work. But of course it is slightly different.  QE is the term used for monetary policy that impacts the supply of base money at the zero bound.  So it’s possible that this type of monetary policy is less effective, although the empirical evidence suggests that QE was effective in the US, and more recently in Japan.  On the other hand future QE might not be effective, it entirely depends how it’s used.  If monetary policy is 99% signaling, then the argument should not be about the 1% (QE) it should be about the 99% (signaling.)  So the post by Gerard MacDonell isn’t so much right or wrong, as mostly beside the point.

The success of future Fed policy will depend almost entirely on the signaling element.  The Fed recently raised rates, which tells us that NGDP is about where they want it.  And by backwards induction it seems like the Fed did not want rapid NGDP growth a few years ago, as if they had wanted it then they would not have raised interest rates this past December.

Here’s thought experiment that might help.  Imagine a NGDP graph built on a large flat piece of plywood.  Drive a stake into the point where NGDP was in mid-2009.  Then drive another stake in where it was at the end of 2015.  Connect the two pegs with a string and pull it tight, so that the string is taut.  That’s the NGDP path that the Fed should have been favoring, if we assume that it was acting rationally.  That is, it behaved over the past 6 years as if it wanted NGDP to growth at a roughly stable pace between the level of mid-2009 and late 2015.  And guess what, that’s almost exactly how it did grow.

Screen Shot 2016-01-13 at 8.59.28 PM

Now you might counter my claim by insisting, “Oh no, the Fed really hoped to get a much faster recovery, a much higher growth rate for NGDP.”  Except there is just one problem with that alternative hypothesis—in that case it would not have been rational for them to raise rates in December.  Because if the market knew (back in 2009) that the Fed would raise rates in December, then the intervening NGDP growth path would have been an equilibrium solution for the economy.  (This is also approximately what New Keynesian theory says.)

Now for the curve ball.  I think the person whining that the Fed actually preferred a faster recovery might be correct.  Who’s to say?  Maybe they were sincerely upset by the long drawn out period of high unemployment.  Maybe they preferred faster NGDP growth.  But even if all that were true, then everything I previously said would still be 100% correct.  I said that if they were rational then their policy would have been consistent with the actual growth path, but I never said they were rational.

Perhaps they thought they could have their cake and eat it too—have a fast growth path then act very conservatively at precisely the moment they raised rates.  Perhaps they never read Krugman’s 1998 paper.  I can’t say.  But if we assume the Fed was rational, then we have to also assume that QE “worked”.  The Fed got exactly the recovery in NGDP that it was acting like it wanted.

When people debate whether QE “worked”, it’s not always clear what’s at stake. Obviously it worked in the sense of impacting market expectations; we know that from asset price responses to QE.  But that doesn’t tell us much about the Fed’s (or BOJ’s) broader economic goals.  I think it makes much more sense to focus on the Fed’s policy goals. What’s it actually trying to accomplish?  Why doesn’t it tell us? What should it be trying to accomplish?  Those are the issues that need to be debated, not whether QE “worked”.

PS.  It’s equally beside the point to debate whether negative IOR “works”, or changes in reserve requirements “work”, or discount loans “work”.  These are policy tools for achieving an objective, when the actual debate should be about the objectives.

Bad grammar or bad thinking?

Here’s a typical AP story:

The boldest move left would be a third round of large-scale purchases of Treasurys. But critics say this would raise the risk of future inflation. And many doubt it would help much, because Treasury yields are already near historic lows.

Let’s play around with this story.  How else could we convey the information:

The boldest move left would be a third round of large-scale purchases of Treasurys.  But critics say this would raise aggregate demand.  And many doubt it would raise aggregate demand, because Treasury yields are already near historic lows.

But then the conjunction “and” would be bad grammar.  You’d want to say “on the other hand.”  How about this:

The boldest move left would be a third round of large-scale purchases of Treasurys. Supporters say this would raise expectations of future inflation, and lower real interest rates.  And many doubt it would help much, because Treasury yields are already near historic lows.

Again the “and” is wrong, because if it does raise inflation expectations then the liquidity trap argument is bogus.  And how about fiscal policy:

The boldest move left for Congress would be a payroll tax cut.  But critics say this would raise the risk of future inflation.  And many doubt it would help much, because workers would simply save the tax cuts.

Of course one never sees reporters talk this way.  Never.  Not once.   One never sees reporters discuss both monetary and fiscal policy from the perspective of the standard AS/AD model, where monetary and fiscal stimulus are just two ways of boosting AD.  No, they seem to have some other model in their minds.  What is that model?  Your guess is as good as mine.  It’s not new or old Keynesian.  It’s not new classical or RBC.  It’s not Austrian or monetarist or MMT.  But it has become the standard model for talking about stimulus.

Am I being picky here?  Surely a bit of confused reasoning in the press would not actually impact important policy decisions involving $100s of billions of dollars.  OK, so some reporters don’t understand that fiscal stimulus is just as inflationary as monetary stimulus.  It’s not like you see the GOP leadership bashing the Fed for even thinking about providing additional monetary stimulus at zero cost to the budget, and then weeks later turning around and signalling an intention to massively cut payroll taxes.

Oh wait .  .  .