The End of QE

BBC Article

When QE started at the end of 2008, many were the voices warning that the economy of the world was heading into dangerous uncharted territory.

First, that if there has been inflation, it has been in asset prices, rather than in items of everyday consumer expenditure.

By increasing demand for bonds created out of mortgages, for example, the Fed encouraged the supply of homeloans and cut their prices – thus sparking a revival in the US housing market, a market so desperately important to consumer confidence and the strength of the American economy.

[W]hat has been really striking about QE is that it was popularly dubbed as money creation, but it hasn’t really been that.

The connection between QE and either the supply of bank credit or the demand for bank credit is tenuous.

The rebuilding of the credit-creation machinery may have been helped in the US by QE – which provided a more benign markets backdrop for the painful process of consumers writing off excessive debts and banks taking the associated huge losses.

That is one important reason why the US economy has grown more strongly since the debacle of 2008 than the UK’s – where there has been no comparable reduction in the absolute size of household debts.

~Brief History~ QE1 was the purchase of $600 billion in mortgage-backed securities starting in November 2008. QE2 was the purchase of another $600 billion of securities in November 2010, but this time they were Treasury securities. Then in September of 2012, the Federal Reserve announced QE3 or “QE-Infinity”. Initially buying $40 billion a month of mortgage-backed securities, the Federal Reserve in December 2012 ramped up the purchases to $85 billion a month. In total the Fed has accumulated $4.5 trillion in assets throughout the program. So what have we learned?

My opinion: First, we learned in practice that the zero lower bound (FFR near zero) does not create a scenario where the Federal Reserve is powerless. Luckily, at the time the 2007/2008 Financial Crisis hit we had a Fed Chair who quite literally wrote the book on quantitative easing. Ben Bernanke and Vincent Reinhart published a paper in the American Economic Review titled “Conducting Monetary Policy at Very Low Short-Term Interest Rates” in 2004. In the paper, Bernanke and Reinhart ask the question:

Can monetary policy committees, accustomed to describing their plans and actions in terms of the level of a short-term nominal interest rate, find effective means of conducting and communicating policies when that rate is zero or close to zero?

Second, we learned that QE in the US is not a disastrous practice. Quantitative easing has been in practice in Japan since 2001 with moderate success. But no one knew the potential impact (positive or negative) that QE would have in the US — particularly since the US dollar is the global reserve currency. If high inflation had taken hold, who knows what devastation that could bring. Which brings me to the last lesson learned…

Trust the dudes at the Fed. The Federal Reserve is not some hodge-podge group of politically ambitious carpetbaggers. They are well-trained, well-respected academics who do extremely fine and under-appreciated work. I am always floored when I hear individuals make overly critical statements regarding Fed policy or even the occasional “End the Fed” type rhetoric. I’m sorry, but if you don’t know how to take a derivative then I don’t believe you are in any position to proclaim malpractice in this regard.

Phew, ok, calm down Dan. Serenity now. Serenity now.

In conclusion, great job Fed! Thanks for all of the help and hours/days/years of hard work. I’m sure whoever has been running the trading desk in New York is getting a well deserved vacation right about now.

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