QE after seven weeks

A recent FT piece discussed the progress of QE thus far, and the Fed’s view of what needs to be done next.  Here is a key passage:

The last meeting saw the Fed buy long-term treasuries for the first time in decades. The large initial impact of the move on markets is no longer visible, but officials think the policy was reasonably successful.

Previous staff analysis suggested the $300bn purchase would reduce the yield on 10-year treasuries by 25-35 basis points, and officials think the rate today is about this much lower than it would have been if they had not started buying.

Further purchases are possible, particularly if the Fed again downgrades its economic forecasts. The staff analysis comparing unconventional operations to interest rate cuts suggests more might be needed anyway.

At first glance this passage may look reasonable.  The 10 year bond yield did fall about 50 basis points immediately after the Fed announced its QE policy on March 18.  And since that time rates have more than regained the full 50 basis points, on a few tentative signs of recovery in the economy.  I don’t know whether the QE policy contributed to these “green shoots,” but it is at least a possibility.  But one thing is obvious; the third paragraph makes it very clear that the Fed’s working assumption is that monetary policy is effective, despite the zero rates.  If they didn’t think so, that paragraph would make absolutely no sense.

What makes me go ballistic is the statement that “Further purchases are possible, particularly if the Fed again downgrades its economic forecasts.”  What does this mean?  Are we to infer that if they don’t downgrade their forecasts, there may be no need for further stimulus?

From the very point at which the economy crashed last October, right up to the present, both the Fed and private sector macroeconomists have expressed profoundly incoherent views on two basic questions:

1.  Do we need faster expected NGDP growth?  Or do we not?

2.  Can monetary stimulus deliver that growth, or is fiscal stimulus required?

If the answer to both questions is yes, then we don’t need fiscal stimulus.  If the answer to the first question is no, then we don’t need fiscal stimulus.

I don’t think you will find many serious macroeconomists who look with pleasure on the horrifying fiscal deficits now being contemplated.  And I might add that these deficits are twice the size of Reagan’s deficits during the equally severe 1982 recession—even as a share of GDP.  Of course very little of the fiscal stimulus has actually been spent, and Congress could easily scale back the stimulus package in the out years if necessary.

What is my point?  That it would be unconscionable for the Fed to in any way pull back on its announced QE goal of more than $1 trillion dollars before every single dollar of (uncommitted) fiscal stimulus was withdrawn by Congress.  Were they to refrain from additional monetary stimulus on the grounds that they were satisfied with the prospects for economic growth, then they would merely be confirming the suspicions of all right wing economists like myself that thought fiscal stimulus was never about “recovery” but rather always about “big government.”

Now some might argue that the Fed can’t control Congress, and that they have to do what’s best under the assumption that Congress is going to spend this money regardless of how rapidly the economy recovers.  My response is that it was the Fed itself that called for fiscal stimulus.  And they did so because they felt that monetary policy, unaided, could not get the job done.  If the Fed is pulling back on its QE plans because they expect satisfactory growth, then why have they not called for Congress to repeal the stimulus first?  Unlike fiscal stimulus, monetary expansion reduces budget deficits.

My second question is why in the world would the Fed even entertain the possibility that further QE might not be needed?  Are there any credible forecasts out there that show satisfactory growth in the near future?  Unemployment is 8.9% and almost everyone expects it to go much higher in future months.  Even apart from the opportunity cost of fiscal policy argument, does anyone seriously believe more stimulus is not needed?

BTW, you might be thinking that I am ignoring the inflationary consequences of QE.  Yes, I am ignoring the inflation that neither I nor the financial markets see from the huge increase in the monetary base so far this year.  But let’s back up one step—has there actually been a huge increase in the monetary base this year?  I suppose it depends on one’s definition of “huge.”  As this data from the St. Louis Fed indicates, the actual increase in the (seasonably adjusted) base has been less than 3% so far this year.  So I think my skepticism about QE last March was well justified.  And yes, they are still paying banks to hoard the ERs.

[BTW, please don’t tell me that the base is considerably higher than in March. I know that. My point is that we were led to believe that the Fed planned something a bit more ambitious than regaining the base levels of January. If you don’t believe me, go back and read the initial press reports full of terms like “unprecedented.”]



7 Responses to “QE after seven weeks”

  1. Gravatar of David Pearson David Pearson
    12. May 2009 at 06:29


    The behavior of the base is perhaps more nuanced than your post implies.

    The “liquidity facilities” like TAF mostly resulted in ER hoarding by the banks. Thus, if and when they are reversed, even you would admit that the effect on stimulus would be small.

    On the other hand, the longer-duration MBS, agency, and Treasury purchases are presumably not hoarded. These purchases arguably increase required reserves, not excess reserves. However, the problem is that, with sweep accounts, it is difficult to obtain a signal from the behavior of required reserves.

    So one could imagine a situation in which ER hoarding falls but long-duration purchases cause M2 to rise. The effect of long-duration purchases is felt in velocity rather than the base. Is this possible? I suppose you have to assume that money “leaks” away from the Fed balance sheet. I’m don’t know if this is even possible, but it seems that it depends on the complex behavior of required reserves.

    The key is that one set of programs (liquidity-oriented) leads to hoarding; the other set (duration-oriented) do not, necessarily. As one replaces the other, what behavior would you expect to see in M2?

  2. Gravatar of pushmedia1 pushmedia1
    12. May 2009 at 09:10

    “Yes, I am ignoring the inflation that neither I nor the financial markets see from the huge increase in the monetary base so far this year.”

    Maybe the markets expect no further QE?

  3. Gravatar of ssumner ssumner
    12. May 2009 at 13:33

    David, The short answer is “no.” The base is the base. Whether banks hoard base injections does not depended on how the money is injected, unless the method of injection sends signals about its permanence. And unless I am mistaken almost all the extra reserves have gone into ERs, not RRs, whatever the source. So I don’t think your premise is accurate.

    pushmedia1, That’s exactly what worries me. I think the markets do expect little or no further easing, and are signaling that the Fed has done nowhere near enough. But again, my main point is that we should not even be contemplating anything less than massive further monetary stimulus when we are running nearly $2 trillion dollar deficits. That is crazy. Further monetary expansion would allow us to run much smaller deficits. I hope that point was clear, maybe I didn’t emphasize it enough.

  4. Gravatar of Bob Murphy Bob Murphy
    12. May 2009 at 14:19


    Do you ever wake up at night and doubt your position? You are saying, “It’s reckless for the government to borrow and spend $2 trillion. Rather than that, they should print up $2 trillion in green pieces of paper and hand them over to bankers. Then we could fix the economy at no cost.”

    Does that sound right to you?

  5. Gravatar of ssumner ssumner
    13. May 2009 at 04:56

    Bob, I’d like to see a much smaller money supply, which we would have if we had a much more expansionary monetary policy. A year ago the monetary base was one half its current level, and policy was much more expansionary. So I don’t agree with the premise of your question. BTW, I don’t favor the Fed handing money to bankers, I favor having them buy bonds from non-bankers, and having the new money be held by non-bankers. In other words, I oppose current policy practices. I favor a monetary policy regime where bankers play no role (except to hold a bit of vault cash.)

  6. Gravatar of tom s. tom s.
    15. May 2009 at 18:04


    You have the best blog going, but I’m afraid your reply to Bob is confusing to me and perhaps others as well. You say a more expansionary monetary policy results in a smaller money supply. I don’t get that. If as you say the the monetary base has doubled in a year isn’t that expansionary by definition?

  7. Gravatar of ssumner ssumner
    21. May 2009 at 03:51

    Tom, Sorry I missed this one earlier. No I don’t think a rising monetary base is expansionary by definition, nor do most other economists. The base rose sharply between 1930-33, and the vast majority of economists regarded that as a tight money policy. Tight money produces deflation, which drives nominal rates toward zero. At zero nominal rates the real demand for cash may rise sharply. In this particular case the problem was mainly interest on reserves, a contractionary policy that led to a much bigger demand for reserves. Monetary policy is about changes in both the supply and DEMAND for base money.

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