Is the Fed’s policy of quantitative easing effective?

This question is particularly relevant as the Federal Reserve meets September 17-18 to discuss tapering of its large scale asset purchase program.  That conversation has caused markets to convulse this summer.

We conclude that, while current Fed actions may be politically necessary to improve the depressed state of economic conditions, quantitative easing by itself has had little effect on economic output.

How stimulative are large asset purchases?  “The Federal Reserve’s large-scale purchases of long-term Treasury securities (quantitative easing) most likely provided a modest

[emphasis added] boost to economic growth and inflation,” according to a research paper published by the Federal Reserve Bank of San Francisco.  The paper goes on to say, however, that the effects are greatly dependent [emphasis added] on the Fed’s guidance that short-term interest rates remain low for a considerable period.  The expectation of low short-term rates for an extended period “probably has greater effects than signals about the amount of assets purchased.”  In summary, without expectations of low short-term rates for a very long time, large scale asset purchases produce little effect on GDP growth.  In reading this, remember, as one commentator noted, “you have here Federal Reserve system economists writing publicly about the policy of the Federal Reserve.  There is a certain diplomatic politeness required in such papers.”

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Large scale asset purchases fail to bring strong economic growth.  The latest round of large scale asset purchases will fail to bring about stronger economic growth, just as the first and second rounds, according to Hoisington Investment Management.  They note that Fed advocates believe the ‘wealth effect’ –the propensity of people to spend more when they feel wealthier—will bring life to the economy.  However, the opposite is true.  “The impact of wealth on spending is miniscule…the unintended consequence of these Federal Reserve actions is to actually slow economic activity….how the Fed expects the U.S. to gain any economic traction from higher stock prices when rising commodity prices are curtailing real income and spending is puzzling.”  Rising commodity prices lead to higher consumer prices and greater burdens on those with the lowest incomes.  “These price increases had a devastating effect on worker’s incomes” during the first and second rounds of large scale asset purchases.  Fed actions lead to higher food and fuel prices; the shock wave reverberates around the world, with many foreign economies being hit adversely.”

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The old “pushing on a string” analogy is relevant:  Paul Volker.  In an article entitled “The Fed and Big Banking at the Crossroads,” Paul Volker, former Federal Reserve Chairman, recounts his experience at the Fed that began in 1949, and notes many of the concerns then come into play now, sixty years later .  He notes “the beneficial effects of the actual and potential monetizing of public and private debt, which is the essence of the quantitative easing program, appear limited and diminishing over time.  The old ‘pushing on a strong’ analogy is relevant.”

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And in case you missed it, click here to read last week’s blog post which focuses on signs of optimism in the economy.

We hope you enjoy reading these articles along with us and that you find them informative.  Please forward this to your friends and family.

J. Mark Nickell & Co.


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