Felix Salmon

The case against QE

By Felix Salmon
November 15, 2010

An impressive group of right-leaning technocrats has signed an open letter to Ben Bernanke, objecting to his adoption of QE2. And it’s hard to disagree with what they have to say:

We believe the Federal Reserve’s large-scale asset purchase plan (so-called “quantitative easing”) should be reconsidered and discontinued. We do not believe such a plan is necessary or advisable under current circumstances. The planned asset purchases risk currency debasement and inflation, and we do not think they will achieve the Fed’s objective of promoting employment.

It seems clear that the G20 meeting in Seoul achieved absolutely nothing largely because of the unfortunate timing of Bernanke’s QE2 announcement. It overshadowed everything else, it put Obama on the defensive, and it made it impossible for the G20 to agree on anything. I don’t think that the FOMC anticipated the volume of the international criticism of U.S. policy, and that alone is reason to reconsider what they’re doing. After all, if a policy designed to increase confidence only serves to increase mistrust, it probably isn’t working.

QE isn’t necessary: there’s no immediate and obvious harm which will befall the U.S. if it’s discontinued. If it doesn’t increase employment or decrease unemployment, there’s certainly no reason to do it. And so far the evidence that QE has any effect on employment is slim at best. So yes, there’s a case to be made that QE should be discontinued.

The letter continues:

We subscribe to your statement in the Washington Post on November 4 that “the Federal Reserve cannot solve all the economy’s problems on its own.” In this case, we think improvements in tax, spending and regulatory policies must take precedence in a national growth program, not further monetary stimulus.

This is surely true, and I doubt that anyone on the FOMC would disagree. Indeed, the Fed’s own response to the letter explicitly agrees with this point:

The Chairman has also noted that the Federal Reserve does not believe it can solve the economy’s problems on its own. That will take time and the combined efforts of many parties, including the central bank, Congress, the administration, regulators, and the private sector.

But back to the letter:

We disagree with the view that inflation needs to be pushed higher, and worry that another round of asset purchases, with interest rates still near zero over a year into the recovery, will distort financial markets and greatly complicate future Fed efforts to normalize monetary policy.

Markets have definitely been distorted by QE2. Here’s a screenshot from Reuters’s brilliant interactive graphic:


If these assets were to fall as much as they’ve risen in the past couple of months, the effect on markets could be devastating. And what’s particularly noteworthy, here, is that the main asset that the Fed is targeting—long-dated Treasuries—is pretty much the only asset which hasn’t moved at all. Bernanke’s blowing bubbles, here, and there’s an increasing chance that it’s all going to end in tears.

The letter concludes:

The Fed’s purchase program has also met broad opposition from other central banks and we share their concerns that quantitative easing by the Fed is neither warranted nor helpful in addressing either U.S. or global economic problems.

I’m inclined to agree. In theory, QE can help jump-start U.S. economic growth, which in turn will help the rest of the global economy. But when no one in the rest of the world seems the slightest bit grateful for the Fed’s help on this front, something is clearly amiss.

The Fed’s job is not to try to replicate a fiscal stimulus by monetary means, and global policymakers don’t believe that the Fed is truly independent of the U.S. government. (I don’t believe that either.) QE is an experiment, and like all experiments it can go wrong. At the very least, the Fed should have some clear criteria by which they can determine whether it is working or not, and should commit to unwinding the program should the latter be the case.

18 comments so far | RSS Comments RSS

>>And it’s hard to disagree with what they have to say>>

No it isn’t. Unemployment is unacceptably high and the economy is too slow. QE2 should help, although the magnitude is far from clear.

>>The Fed’s job is not to try to replicate a fiscal stimulus by monetary means>>

The Fed’s job is maximum employment and price stability. What’s your suggestion for increasing employment?

Markets distorted?? That’s a rather loaded phrase. Maybe the markets recognize QE2 as helpful and are reacting favorably. If markets went up following a good GDP report, would you say the GDP had distorted markets?

The rest of the world is upset because QE2 has led to a lower dollar, while a higher dollar helps everyone else’s exports. The rest of the world care more about their own exports and employment then they do about the US.

Posted by 3oosion | Report as abusive

The economy is already distorted, at least partly because China has been keeping the dollar artificially high. Does it count as “distortion” if you are acting to remove a distortion?

Posted by TFF | Report as abusive

I think economists need to be more transparent and that includes being more clearly associated with their past record.

Right leaning economists are distinguished in the last 2 years or so for getting into a lather about the fiscal stimulus leading to inflation. How is that working out?

There is also a long history of right (and center) economists leading the charge for deregulation. How did that work out?

So they are concerned. So what? For folks that have a history of being wrong, wrong, wrong, that should not lead to our being concerned.

Posted by nyet | Report as abusive

I have yet to hear anybody define how QE2 is different from what the Fed does everyday – that is, monetary policy. The Fed usually sets the short rate, the Fed Funds rate. They do this by buying and selling and borrowing and paying back. There is absolutely no difference between that and QE2.

The letter in the WSJ and the blowback coming from foreign leaders is merely politics. No more, no less.

Posted by Bernanke | Report as abusive

No difference, Bernanke, just the difference between a canoe and the Queen Elizabeth II. (Isn’t that what QE2 stands for?)

The Fed’s book has grown dramatically.

Posted by TFF | Report as abusive

One of the Fed’s mandates is to foster full employment. Given that mandate, does it not seem logical that “the Fed’s book” grow dramatically when faced with unemployment in the 9 1/2 – 17% (pick your measurement) range?

Posted by Bernanke | Report as abusive

Um… Yes? It seems a logical response to the present situation. We need to push the capital onto the field from the sidelines, we need to squeeze profit margins, and we need to devalue debt to match the devalued labor.

You asked, however, how this is different from what they do daily. The difference is in the quantity of bonds being purchased.

If I were snarky, I would note that their mandate requires them to hold top-quality assets (no junk bonds). So why are they buying US Treasuries?

Posted by TFF | Report as abusive

I know! We can get Bernanke to stop this madness! We can have him publicly step into the whole tax cut fight between Obama and the Republicans, say that the entire Bush tax cut regime needs to be repealed and the US needs to take that money and spend $800M/year over the next three years on infrastructure, alternative energy and education to reduce unemployment to 6.5%, reduce our excessive use of carbon and educate our children for the future!

It’s perfect! It will work! We’ll all be better off!

Why are you all laughing? Didn’t Alan Greenspan intervene to make sure tax and spending policy was what he in good faith thought it should be for the health of the country? Stop laughing!

Posted by Dollared | Report as abusive

Says Brad DeLong:”The problem with our economy is not that something bad happened to our productive capacity while the flow of nominal spending continued to blip along, it is that something bad happened to the flow of nominal spending and that carried real production and employment down with it. At the moment our flow of nominal spending at $14.7 trillion per year is some 12% below its pre-2008 trend. And in the absence of any 12% decline in prices and wages, that shortfall in spending has to produce our current macroeconomic distress: there is not enough “money” to support enough of a flow of spending to chase all the goods we could produce. We don’t have a deficiency of real supply (for whatever reason). We have a deficiency of nominal demand.” Ergo.

Posted by hansrudolf | Report as abusive

Says Brad DeLong:”The problem with our economy is not that something bad happened to our productive capacity while the flow of nominal spending continued to blip along, it is that something bad happened to the flow of nominal spending and that carried real production and employment down with it. At the moment our flow of nominal spending at $14.7 trillion per year is some 12% below its pre-2008 trend. And in the absence of any 12% decline in prices and wages, that shortfall in spending has to produce our current macroeconomic distress: there is not enough “money” to support enough of a flow of spending to chase all the goods we could produce.

What does “nominal” spending mean? Is that spending on a credit card? And its OK if you don’t pay it back – just keep spending???
“in the absence of any 12% decline in prices and wages,…” – really? Had wages declined 12 we would be OK? OH, if wages and prices declined! Isn’t QE specifically designed to prop up prices? Or is it just to lower interest rates? By how much? How much effect will a fall in interest rates of 0.2% have on employment? And the problem is the goods “We could produce” – like houses? We seem to produce lots of them, except we couldn’t sell them at their real cost. Or somebody was charging far more than they were really worth? – why don’t we let them sell at a price people can afford? (a “nominal’ price, or is it a “real price” the price that people can afford???)

Posted by fresnodan | Report as abusive

“Nominal spending” refers to “dollar value” of spending. And yes, spending (both nominal and otherwise) was pushed unsustainably high for several years through the credit card and refi boom. The Bush tax cuts pushed the federal government into a massive deficit, yet the consumers responded by INCREASING their credit utilization.

Anybody complaining about the drop in “nominal spending” is missing the point, because things COULD NOT continue the way they had been going from 2002-2006. It was essentially a Ponzi scheme, and like all Ponzi schemes it eventually toppled hard.

The fundamental problem is that our production costs are uncompetitive due to high wages and an artificially strong dollar (propped up by China). Other countries can’t afford to buy from us because the dollar is so expensive. *WE* can’t afford to buy our own goods because they are so expensive (and thus we outsource jobs and import manufactured goods). So we end up with an economy that is largely a closed circle of services, fed by a steady inflow of imports and credit.

You have to fix the fundamental problem, and that requires a devaluation of the dollar (since China refuses to allow the yuan to appreciate significantly) and reduced consumption. Rising productivity will help, but that isn’t something you can order up overnight.

Posted by TFF | Report as abusive

From m’blog (jdbtrading.blogspot.com):

Even Felix Salmon is against QE, on the grounds that it will do nothing to help the employment situation. This was the reason why I thought, back in the summer, that more QE was unlikely.

But I don’t think the latest round of QE is about employment. It is about inflation (and indeed, that is how the idea was originally presented in board members’ speeches, with employment coming in later). This is what I think is happening. Ben Bernanke sees a real risk of deflation in the US. Deflation is very hard to escape: yes, in principle, the Fed could buy the equity market, or the housing market, or raise its inflation target, or who knows what else. But these things are politically impossible. And if deflation took hold, the employment situation could get even worse than it is today. In addition, with the normal rotation of FOMC voting positions, there will be more hawks on the board next year, which will make it harder for Mr. Bernanke to embark on QE then.

It therefore makes sense for QE2 to start now. The idea is to raise the price of financial assets, and through a wealth effect (US households own a lot of equities and know how they are performing) to depress the savings rate (i.e. get consumers to spend rather than paying down debt), and to encourage investment, in order to tide the economy over until the deflation threat recedes. That will not necessarily reduce unemployment compared to its level today, but it will reduce unemployment compared to what it would otherwise have been, had deflation taken hold.

This policy is not sure to work, but given the downside risk inherent in our present situation, it makes sense to do something rather than nothing. If it fails to prevent deflation, we can only hope that the political environment is receptive to more radical solutions when the times comes. If, on the other hand, it works so well that it creates excessive inflation, the Fed has the tools to deal with that problem, in the form of short-term interest-rate increases and the payment of interest on reserves. And there is sure to be no shortage of political support for rate hikes in the face of high inflation.

In summary, the Fed’s current action comes from two asymmetries in its situation.

1. Political support for tightening is much more likely than political support for easing, so you have to ease when you can.
2. If you have deflation, you can be trapped; if you have inflation, you can just do a Volcker. So you need to do everything in your power to prevent deflation.

Posted by JDB | Report as abusive

The think to do know is keep an eye on gold and silver. There’s a battle to keep them down but when you have the QE and central banks becoming net buyers of gold the end result is going to be a volatile bull market that is going to continue a climb upward.

Posted by goldtracker | Report as abusive

Oh, I meant to suggest that people can track the gold and silver spot prices for free with http://www.learcapital.com/exactprice

Posted by goldtracker | Report as abusive

As someone who is very concerned about government debt, I worry that QE is simply enabling our profligate politicians.

Still, I can totally see were Bernanke is coming from. A dollar devaluation helps with American jobs quite a lot. Study the Great D to see when happens when currencies strengthen a lot into the teeth of a recession.

Yes, yes, I know manufacturing does not account for that many jobs any more. But there are 1000 service sector jobs that benefit from devaluation.

- US vacationers spend their dollars locally
- Foreign vacationers come here
- Gas prices which feel higher curtail our consumption and reduce the capital we send to OPEC
- The appeal of outsourcing is greatly reduced, both presently and in terms of expectations
- The drive to automate, which is largely due to costly workers and cheap capital, is reduced.
- Jobs which use rising asset prices as lubricant (real estate, finance, construction) see better employment
- Companies which are safely sitting on huge cash hoards in a deflationary world must invest in R&D and otherwise seek returns not otherwise available (a huge effect!)
- Drive foreign purchases of our assets (stocks, buildings, etc.) to stimulative effect.

@JDB — The Fed is definitely not powerless against deflation. Unsanitized printing can achieve it, if it really were to become a serious problem. So far it hasn’t been. Ask Mugabe: print, spend, repeat! I don’t recommend a huge amount of that, but the recipe is simple if you *need* inflation.

Posted by DanHess | Report as abusive


In theory, I agree, but my point is that it would be politically impossible. Look at the slightly deranged international reaction to the latest round of QE, the Tea Party caucus, and the Japanese experience. Physically printing money and spending it would likely have politicians and the public up in arms. And how would the Fed spend it? Not on financial assets — that isn’t the point. And a few extra staff parties, however lavish, wouldn’t really move the needle. The spending would have to be done by the fiscal authorities — but that is fiscal stimulus, which is already off the political agenda on the spurious grounds that “we can’t afford it.”

It is really very far from easy to get out of persistent deflation.

Posted by JDB | Report as abusive

@JDB —

I sort of feel like with the standoff we have between right and left, plus with Bernanke at the Fed, we can actually get exactly the fiscal stimulus you are talking about.

The right is fiercely against tax increases of any kind. The left is fiercely against spending cuts of any kind. Witness its almost complete unwillingness to take that tiniest of baby steps, addressing earmarks.

So where does that leave us? With a huge *already existing* unaddressed structural deficit that is paid for directly out of thin-air fed money, day after day, year after year until the bond market vomits and goes into siezure. That is as though there is a giant Friedmanite new-money-financed tax cut every year until ________.

QE looks bad at the moment, but when there is a crisis of some kind (I think a bond crisis, but maybe a crisis in risk assets a-la March of 2009) a further round or two of Q.E. won’t meet as much protest.

That’s my view and so I shun bonds.

Posted by DanHess | Report as abusive

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