The case against QE

November 15, 2010
open letter to Ben Bernanke, objecting to his adoption of QE2. And it's hard to disagree with what they have to say:

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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.


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