Bernanke explains QE2

By Felix Salmon
November 4, 2010
Ben Bernanke might not be giving Trichet-style press conferences, but he is at least taking to the op-ed page of the Washington Post to explain yesterday's decision. Here's what he's trying to achieve with his quantitative easing:

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Ben Bernanke might not be giving Trichet-style press conferences, but he is at least taking to the op-ed page of the Washington Post to explain yesterday’s decision. Here’s what he’s trying to achieve with his quantitative easing:

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.

I don’t think that lower mortgage rates are going to make housing more affordable: there’s no evidence that I can see that rents fall when interest rates drop. If anything, the opposite is true. And in the wake of being stung by predatory adjustable-rate mortgages in the past, most homeowners now have fixed-rate mortgages, which don’t get any cheaper when rates fall. Or, of course, they have no mortgage at all.

So there really only two groups of people who are affected by the lower mortgage rates. One is homebuyers. Their numbers have shrunk to historic lows. And the other, as Bernanke explicitly says, is people refinancing their mortgages. But this round of QE isn’t going to bring mortgage rates down to levels significantly lower than they’ve been in the recent past: anybody liable to refinance on lower mortgage rates is likely to have done so already. So the rolls of potential refinancers are pretty thin as well.

Bernanke lists two other positive effects of QE, though. The first is that “lower corporate bond rates will encourage investment” — a statement contingent on the idea that there are firms out there who would love to borrow money to invest, but they find the interest rate they would have to pay to issue bonds too damn high. I can’t think of any companies like that, and so this effect, too, is going to be decidedly marginal.

Finally, Bernanke gets into very dangerous territory indeed: he explicitly says that he’s trying to boost stock prices. Surely if we’ve learned anything from Greenspan’s mistakes it’s that the Fed shouldn’t be trying to support stock prices, and that attempts to do so are liable to end in tears.

Meanwhile, although Bernanke says that “the FOMC has been cautious, balancing the costs and benefits before acting”, he only mentions one cost, inflation — and that cost he mentions three times. He doesn’t even hint at other costs, such as increased market uncertainty and volatility, or increased currency-related difficulties as investors pile in to the global carry trade.

It’s also odd that Bernanke is talking down the risk of higher inflation given that, as Brad DeLong says, the only way that QE is going to work is if it results in higher inflation expectations. In a piece of clever math, DeLong calculates the value to the market of the Fed’s interventions at just $7 billion a year, which clearly isn’t enough to move an economy the size of the US. “Unless this moves inflation expectations in a serious way, it is hard to see why they came out here,” he concludes.

So while I welcome Bernanke trying to explain his actions in the form of an op-ed, I’d be much happier if he did so in the form of a press conference, or some other place where people could ask him questions. He’s good at communicating; why doesn’t he use those skills better?

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Comments
6 comments so far

Felix,
You got all points right, and Bernanke is flat wrong.
A brave new era of stagflation is dawning. In other words, the underlying weakness in the US economic machine is morphing into something new.
Never a dull moment…

Posted by yr2009 | Report as abusive

I second the reaction here – as a consumer, I don’t see the benefit of lower rates now that I didn’t already see a year ago. I’m also not sure what businesses would be more willing to invest in idle production now as opposed to 6 months ago.

If the Fed’s history over the past 20 years is any indication, this is not going to end as planned.

Posted by djiddish98 | Report as abusive

Well argued, Felix. WaPo should print this blog as a counterpoint.

Posted by Gotthardbahn | Report as abusive

The Fed is trickling down on us, flooding our economy with liquidity, the farm is saved!

Posted by Woltmann | Report as abusive

A terrific, thought-provoking post!

I have to disagree sharply with DeLong that the Fed’s actions made little difference. DeLong argues that because the 5 year is at 1.17, the Fed’s actions do not matter. I would argue instead that the 5 year was at 1.17 because the Fed was loudly announcing its plans to buy and everyone had front-run the Fed already. If the Fed suddenly changed course and refused to buy, interest rates would shoot upward.

“Brad DeLong says, the only way that QE is going to work is if it results in higher inflation expectations. ”

I agree with Brad. But I also think this will be self-fulfilling. How?

(1) The Fed buys bonds at very low rates with ‘new’ money. Check.
(2) The Fed holds these bonds long term (so far so good).
(3) Eventually, while inflation expectations raise interest rates rise, causing real, permanent losses on the part of the Fed.
(4) This Fed loss shows as a gain on balance sheets all over the world. This is brand-new money, that the Fed printed, spent, and that it will never recoup.

In fact the Fed has already injected brand new money into the real economy in the form of bond gains that have already been booked by many funds which sold to the Fed.

I am seeing the point of Ray Dalio at Bridgewater. He argues (my understanding) that we are in a ‘D-process’ where creditors must sustain losses because debtors can’t pay it all back. This can happen by (a) massive defaults and deflation (Great Depression) or (b) prolonged low returns on debt or (c) inflation, or some combination of the above.

The Fed is successfully avoiding (a). That much is very clear to me.

Posted by DanHess | Report as abusive

Exactly, DanHess. Debtors could barely repay creditors when times were good. Now that the economy has retrenched a bit, they are in over their heads.

We’re seeing moderate but sustainable levels of default, dragged out over a few years. This is a “fair” way of destroying debt because it directly impacts only the creditor and the debtor, however if the rate of defaults rises too high then it can bring down the whole system. Meanwhile, NOTHING HAPPENS in the economy until the imbalance has cleared (and at this rate it will take a while).

Quick defaults = (a)
Slow defaults over a long period of time = (b)

The Fed is trying for (c), which is the best bet to destroy wealth quickly without bringing down the whole house of cards.

Posted by TFF | Report as abusive
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