The Economist  judges that it is working . Long term interest rates have fallen since Bernanke announced the Fed was going to restart the printing press, usefully making the US government deficit a tad easier to finance. The stock market has been juiced, which may have a wealth effect on aggregate demand. And the US dollar has fallen against currencies that float against it. In short, there may be a modest positive impact on US growth and employment.

“Under QE the Fed buys long-term bonds with newly created money. This lowers long-term yields and chases investors into riskier, alternative investments. The real yield on ten-year, inflation-indexed Treasury bonds has fallen from 1.05% to 0.5%, a result of relatively flat nominal yields and a rise in expected inflation. The yield on their five-year cousins is negative…  Share prices are up by 14% in the same period. Lower yields make the dollar less appealing: it has duly fallen by 5% against the Japanese yen, by 9% against the euro and by 5% on a trade-weighted basis.”

Over at the FT, Martin Wolf has also jumped to the Fed’s defence.

“Boiled down, the criticisms of the Fed come down to two: its policies are leading to hyperinflation; and they are “beggar my neighbour”, in consequence, if not intention.

The first of these criticisms is not just wrong, but weird. The essence of the contemporary monetary system is creation of money, out of nothing, by private banks’ often foolish lending. Why is such privatisation of a public function right and proper, but action by the central bank, to meet pressing public need, a road to catastrophe? When banks will not lend and the broad money supply is barely growing, that is just what it should be doing.”

He adds

“The sky is not falling. But this does not mean the Fed’s policies are the best possible. It is probable that any impact on the yields on medium-term bonds will have a modest economic effect. It would be far better if the Fed could shift inflation expectations upwards, by issuing a commitment to offset a prolonged period of below-target inflation with one of above-target inflation. A decision to monetise additional government spending might be an even more effective tool.”

 This last comment strikes me as the crux of the matter for progressive economists. QE may have some impact in a liquidity trap when interest rates cannot go lower, but it is not going to have a big impact so long as business is unwilling to invest, households  are paying down debt, and banks are already flush with cash.  As Krugman has ben arguing, fiscal stimulus would have much more impact, but Bernanke has to play the only card he has to play.

By contrast, think of the potential impact of fiscal stimulus directly financed by the Fed, the alternative Wolf briefly suggests. This could have helped finance state Budgets in deficit, avoiding the pending decimation of public services, and could have been used to extend expiring unemployment benefits for the many long term unemployed. The total amount of QE2 comes to about $2,000 per US citizen. Issuing demogrant cheques via government grant or, better, doing helicopter drops of cash on low income neighbourhoods would have been better.

Like the Economist and Wolf, I am not very sympathetic to the view that the US is simply exporting  its troubles to others. Sure QE2 will hit the foreign reserves of  surplus countries and is lowering the dollar – but not aginst the yuan and the other emerging economy currency fixers – but that is fair game to signal that the US can no longer be the borrower of last resort for the globe.  This is not a morality story, but the onus should be on China and Germany to pick up the slack rather than crow about their superior competitiveness.  

That said, this could all get very ugly. One can only hope that the G20 in Korea can articulate some coherent alternative to competitive austerity and  the patent impossibility of everybody getting out of the mess through export led growth. Not that there is much sign of that. Sigh. 

One last thought. Last month’s rather appalling trade data sugggest that the Bank of Canada view that exports and business investment will keep growth alive as stimulus fades needs, well, recalibrating.  With the dollar at parity, can recovery continue? We may just have to have a round of QE here as well. 




  • My main critique is the one sidedness of this approach. Other countries have deficit problems and have been forced into gut wrenching austerity. The US avoids such perils by simply printing. And there is a global cost of instability by doing this, as exchange rates outside of the fixers are forced to run with it. (look at our dollar- are we ready for 1.10?) I do not see why you feel that is a not quite the huge issue many are making it out to be. More instability is not what we need.

    I also have a huge problem that again those involved seemed more concerned about financial health and not production health- potentially I am becoming a bit biased, but I just do not see policy makers in the US concerned about a real recovery- again this is a half measure that does not deal directly with main street problems. It surely will not chase private cash into productive investment, in fact it is merely chasing them back into the bubble cycle, and that is not a sustainable solution.

    Obama must start giving Bernake more cards, although I do think his linkage to the Reps, is not boding well.

    Chase private cash into productive investment and then I might be more inclined to say at least we are pointing the boat in the right direction.


  • Who knows what the FED is doing. Bernake publicly said he was not trying to raise inflation expectations. Then administration officials said they were not trying to the lower dollar. So even if I thought monetarism Mark III (QEI II III IV…) was right-headed in its causal logic I would be confused.

    There is also the fact that there is not one interest rate but many and on the unsecured credit side of things real interest rates are high. Now if the American consumer could get access to say 2% consolidation loans allowing them to swap out of their high servicing costs that would have a real and immediate impact on consumption and the rapidity of debt de-leveraging. Of course that would hit Banks’ profits and there is some evidence that QE is really about re-capitalizing US banks.

  • The problem with QE2 is that it encourages the U.S. banks to send money abroad, enhancing the “carry trade.” It does little to expand U.S. domestic demand. American Bank lending to Australia has pushed up their dollar. Emerging nations are experiencing widening volatility of short term capital flows, as the 600 billion shifts out of the U.S.
    The Chinese and Germans are right, the U.S. growth model is flawed. This cannot be fixed by the Fed. alone.
    The Fed could lend to State governments, the ECB was forced to do this by the crisis. I don’t know enough about its operations to understand why this is not discussed. But then Bank of Canada lending to the provinces has not been much discussed since the Chorney study for the CCPA back in the late 80s.
    Overal quantitative easing relies on a money supply expansion. It is policy in a Friedman mode of thinking. I agree with Andrew, fiscal policy makes more sense, and I think Stiglitz rather than Krugman has a more interesting take on this. Stiglitz wants to increase U.I. benefits for instance.
    What is not being much discussed is banking policy as an alternative to monetary policy. The banks are not lending, the are de-levering. Monetary expansion does not change that. The U.S. has a banking problem, big time worries about delinquent mortgage debt coming back to create a solvency crisis.
    The November 9 FT letter by the Financial economists (google Anat Admati of Standford) suggests that that Basel III is flawed by not making the banks issue and hold enough equity.
    The debt deflationary environment calls out for a closer look at banking policy.
    Following the failure of talks in Seoul to agree on anything except reduce ODA, France takes over from Korea as head of the G20. India and Canada co-chairing an attempt to address the fallout from the currency wars should strike fear into the hearts of Canadians who have followed the foolishness of the Finance Dept. It is also reminiscent of the International Control commission on Vietnam where Canada represented U.S. interests, and India was neutral (Poland represented the Soviet Bloc).
    France has an agenda for broad int. monetary reform. Canada will continue to oppose it, as it opposes the Tobin Tax which would do a lot to reduce the current volatility of capital flows. Our government is a very dangerous player at a time of potentially great international stability.
    The Liberals, Bloc, and NDP need to understand what is at stake by continuing to back the U.S. in its wrong headed attempts to make others pay for its own policy mistakes. Of course, the Conservatives (and Bay St) of course do not see anything wrong in the United States of Inequality (to borrow the recent Slate Forum title), thus are likely to want to scuttle efforts to bring the U.S. into a multilateral regime.
    France may have a right wing government, but it has a long record of opposition to U.S. financial dominance of the world economy, one worth studying and understanding in my opinion.

  • We need to get like and dislike buttons for comments and articles on the blog or a stars rating would probably be more accurate, because Duncan’ comment needs to be rated as five stars.

  • QE2 adds no additional financial assets to the US economy. It is an asset swap of interest paying treasury securities for essentially zero interest reserves. It results in slightly lower interest rates and as a result an increase in the price of bonds and other assets. Bernanke’s hope is that this wealth effect will result in increased aggregate demand. It will also tend to decrease the value of the US dollar a little and increase exports a tad.

    The down side is that it decreases aggregate demand by removing interest paying assets from the economy which is income that is not spent. Pensioners in particular get it in the neck. The net effect on demand is unclear but possibly negative.

    Since the US federal government is politically unable to introduce a second stimulus package that’s about all there is left for the US to do. It would be more effective if targeted at municipal and state bonds since it would send a signal that the Fed was guaranteeing their bonds. That would lower costs for these administrations to borrow and spend more and add to aggregate demand.

    As Duncan points out the European Central bank bought the bonds of several of its member countries (in violation of its rules). It did this to prevent the collapse of the Euro. Nothing stops the Fed from doing the same for the states and municipalities but it has chosen to inflate stock and treasury bond markets instead. To buy state and municipal bonds amounts to the Fed doing fiscal interventions and it looks like it doesn’t want to go there.

    With respect to Canada, our federal government should increase spending to increase demand in the economy and put the unemployed back to work to build a better country. It should target improvements in public transportation, the rail system, social housing, social programs, etc, etc.

  • I am beginning to think that the best thing progressive grassroots forces could do for Canada’s economy today would be to initiate a massive decentralized counterfeiting program and encourage people to fail to check for counterfeit money. That could stimulate the economy at the level of people who actually spend money on goods and services, create a bit of needed inflation, perhaps even help devalue the currency a bit.

  • QE 1 featured the purchase of mortgages and toxic debt coupled with the issue of treasuries, in effect a swap of good debt for bad. It did improve the balance sheets of the banks.It did not re-start lending needed to fuel demand and create jobs on a significant scale.
    QE 2 is the purchase of treasuries by the Fed, paid for by an increase of its deposits with the banking system. This is debt monetization worth $600 billion, pure monetary expansion. The objections heard around the world focus on the undermining of the value of the world reserve currency, and the likely hood this new deposit money will lead to an expansion of bank loans to hedge funds, private equity funds, etc. into currency speculation. In other words the “stimulus” will leak out of the U.S.
    In their Monetary History Friedman and Schwartz argued the great depression was caused by the shrinkage of the money supply. Their chapter The Great Contraction was re-issued as a separate book recently. Helicopter Ben has bought into this line, famously praising Milton for pointing out what to do to stave off depression:expand the money supply.

  • Keith wrote:

    “The down side is that it decreases aggregate demand by removing interest paying assets from the economy…”

    This does not sound right to me. If the fed is buying up newly issued promissory notes with newly issued promissory notes then it is not altering the existing stock of interest paying assets. Or am I wrong?

  • Travis under QE2 the Fed is buying existing treasuries, taking them out of the market. The interest will now revert to the Fed. In Canada it would count as income for the yearly payment by the central bank to the government. I do not know how the U.S. set up works. I assume it means less interest expense and more interest income for the government.
    Taking interest payments out of the market does reduce current purchasing power, but to the extent that interest income is simply rolled over it will not reduce current consumption of goods and services. Keith is right about the effect on demand, I guess the magnitude depends on the propensity to consume of coupon clipping treasury holders which include many pension funds, and foreign central banks.
    The interest earned by the Fed holdings is what reduces interest payments, and affects demand.

  • Here is a good post by Gerry Epstein, found via Krugman. He agrees fiscal stimulus is what we need but questions too much pregressive criticism of QE2 when it is the only Keynesian idea alive in the actual policy world

  • Ben Bernanke giving the reasons for QE2 in the Washington post, November 4, 2010:

    ”…The FOMC decided this week that, with unemployment high and inflation very low, further support to the economy is needed. With short-term interest rates already about as low as they can go, the FOMC agreed to deliver that support by purchasing additional longer-term securities, as it did in 2008 and 2009. The FOMC intends to buy an additional $600 billion of longer-term Treasury securities by mid-2011 and will continue to reinvest repayments of principal on its holdings of securities, as it has been doing since August.

    This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion…”

    KN comment:
    The main hoped for effect is through the wealth effect. interest rates are already so low it is inconceivable dropping them a tad will make any difference to investment or household spending.

    Bernanke is well aware there should be increased fiscal stimulus and has noted such recently. Given that is impossible politically he has undertaken a second best action. It’s not very much but all that seems possible until the Republicans take over and cut taxes and increase military spending to boost aggregate demand. Pretty sad. Very sad for all the unemployed in the US and for the people in countries who bear the brunt of the US military.

    Some countries are unhappy about QE2 because the value of the US will tend to drop as a result of lower yields on treasury securities and this will increase US exports and reduce foreign imports into the US.

    The effect on China is to help their exporters because the yuan is pegged to the US dollar. It will tend to increase inflation which is now a problem in that country.

    QE1 increased excess reserves in the US banking system by about 1 trillion dollars and did not lead to a significant increase in lending by the US financial system. QE2 won’t either.

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