QE3 arrives

By Felix Salmon
September 13, 2012

It’s basically the same thing that we’re used to at this point, but it’s got enough in the way of new bells and whistles to get people excited anyway — and boost economic growth. So, it’s a good thing, even if it’s not in any way revolutionary.

I’m talking about QE3, of course, although I could equally well be talking about the iPhone 5. You’ve heard more than enough already about the iPhone’s larger screen and new connector and so on and so forth, so let’s talk about monetary policy instead.

The main news isn’t the fact that the Fed is back in the market, buying bonds. Indeed, as Binyamin Appelbaum points out, QE3 in volume terms, at $40 billion per month, is significantly smaller than QE1 and QE2.

The innovation comes rather in the messaging. For instance, we haven’t seen anything like this before:

If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.

What this means is that QE3, unlike QE1 and QE2, has no set expiry date. The Fed’s not trying to kick-start the economy any more: instead, it’s promising a steady extra flow of monetary fuel for the foreseeable future — or at least until the labor market improves “substantially”. Which is likely to be a pretty long time.

That would be a big enough deal on its own, but the Fed went even further in the following paragraph, where they all but promised zero interest rates until mid-2015:

The Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.

The job of monetary policy, in the famous words of Fed chairman William McChesney Martin, is “to take away the punch bowl just as the party gets going”. The Fed, here, is essentially disowning Martin, and saying that they’ll keep refilling that punch bowl with high-grade hooch even after the party is getting going.

Of course, there’s wiggle room here, but the Fed has invested a lot in its own credibility, so it’s fair to believe that it’s going to do what it says it’s going to do.

And so while the headlines are all about QE3, the real innovation here is that the Fed is moving aggressively into the world of words rather than deeds. Buying bonds isn’t enough any more: the Fed is now trying to boost the economy by promising to continue buying bonds, in a zero-interest-rate environment, for many, many quarters to come. It’s the promise, rather than the purchases themselves, which is the main difference between QE3 and its predecessors.

In his Jackson Hole speech, Ben Bernanke had a whole section on “Communication Tools”, talking about the “use of forward guidance as a policy tool”, and saying that it has been pretty effective up until now. Today’s announcement is a huge bet on those tools, basically using them to a degree unprecedented in recent history.

The Fed is also specifically targeting mortgage bonds in particular, on the grounds that lower mortgage-bond yields will feed through into lower mortgage rates, which in turn will feed through into healthier housing prices. That’s a stretch: mortgage rates have not been falling in line with mortgage-bond yields, and in any case the relationship between mortgage rates and house prices is tenuous at best. But the Fed has to buy something, if it’s going to do QE operations, so mortgage bonds it is.

None of this is going to make any noticeable difference before the presidential election: it’s all marginal, really. But if it seems as though QE3 is having a bit more of a real-world effect than QE2 did — if, that is, it helps the job numbers rather than just the markets — then the lesson will be clear. The Fed’s balance sheet is a powerful tool to use — but its vocal chords might be even more powerful still.

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Comments
20 comments so far

“The Fed, here, is …. saying that they’ll keep refilling that punch bowl with high-grade hooch even after the party is getting going.”

Correct, and the decision to announce the boot out to 2015 is more imortant than the $40Bn/month topline stuff, as you’ve recognized. Though it does beg the question as to whether The Fed could run the monther of all punchbowl snatches if it suits the situation, say, half way through Obama II. After all, we are talking about a political entity.

Posted by ottorock | Report as abusive

“The Fed, here, is …. saying that they’ll keep refilling that punch bowl with high-grade hooch even after the party is getting going.”

Correct, and the decision to announce the boot out to 2015 is more imortant than the $40Bn/month topline stuff, as you’ve recognized. Though it does beg the question as to whether The Fed could run the mother of all punchbowl snatches if it suits the situation, say, half way through Obama II. After all, we are talking about a political entity.

Posted by ottorock | Report as abusive

“The Fed, here, is …. saying that they’ll keep refilling that punch bowl with high-grade hooch even after the party is getting going.”

Correct, and the decision to announce the boot out to 2015 is more imortant than the $40Bn/month topline stuff, as you’ve recognized. Though it does beg the question as to whether The Fed could run the mother of all punchbowl snatches if it suits the situation, say, half way through Obama II. After all, we are talking about a political entity.

Posted by ottorock | Report as abusive

I don’t agree with you on which difference between QE III and QE II is important. I think the key issue is that QE III is based on purchases of MBS not 7 year Treasury notes. The portfolio balance effects of purchases of assets which are considered risky (like MBS) is very different from the absense of such effect following the purchase of boring safe 7 year notes.

I think a preliminary assesment of the relative importance of portfolio balance and forward guidance is already possible. Forward guidance works through expected future short term rates, which should show up in medium and long term rates. The 10 year treasury rate fell 3 whole basis points on the announcement. I don’t see much of a forward guidance effect let alone much sign that it is bigger than earlier such effects, since the intervention is open ended.
In contrast “Mortgage-bond yields tumbled to unprecedented lows”. Sure looks to me like portfolio balance not forward guidance.

click the funny URL (old URL * new story = big rush)
http://www.bloomberg.com/news/2012-09-13  /yen-strengthens-asian-stocks-little-ch anged-before-fed-decision.html

You ask if QE III is new so lump together the extremely successful QE I with the extremely unsuccessful QE II. My view is that the FOMC is not like Apple and is like Coca Cola after they introduced new Coke. What they had to do was not find something new but go back to the old successful formula.

Posted by robertwaldmann | Report as abusive

I don’t agree with you on which difference between QE III and QE II is important. I think the key issue is that QE III is based on purchases of MBS not 7 year Treasury notes. The portfolio balance effects of purchases of assets which are considered risky (like MBS) is very different from the absense of such effect following the purchase of boring safe 7 year notes.

I think a preliminary assesment of the relative importance of portfolio balance and forward guidance is already possible. Forward guidance works through expected future short term rates, which should show up in medium and long term rates. The 10 year treasury rate fell 3 whole basis points on the announcement. I don’t see much of a forward guidance effect let alone much sign that it is bigger than earlier such effects, since the intervention is open ended.
In contrast “Mortgage-bond yields tumbled to unprecedented lows”. Sure looks to me like portfolio balance not forward guidance.

click the funny URL (old URL * new story = big rush)
http://www.bloomberg.com/news/2012-09-13  /yen-strengthens-asian-stocks-little-ch anged-before-fed-decision.html

You ask if QE III is new so lump together the extremely successful QE I with the extremely unsuccessful QE II. My view is that the FOMC is not like Apple and is like Coca Cola after they introduced new Coke. What they had to do was not find something new but go back to the old successful formula.

Posted by robertwaldmann | Report as abusive

I don’t agree with you on which difference between QE III and QE II is important. I think the key issue is that QE III is based on purchases of MBS not 7 year Treasury notes. The portfolio balance effects of purchases of assets which are considered risky (like MBS) is very different from the absense of such effect following the purchase of boring safe 7 year notes.

I think a preliminary assesment of the relative importance of portfolio balance and forward guidance is already possible. Forward guidance works through expected future short term rates, which should show up in medium and long term rates. The 10 year treasury rate fell 3 whole basis points on the announcement. I don’t see much of a forward guidance effect let alone much sign that it is bigger than earlier such effects, since the intervention is open ended.
In contrast “Mortgage-bond yields tumbled to unprecedented lows”. Sure looks to me like portfolio balance not forward guidance.

click the funny URL (old URL * new story = big rush)
http://www.bloomberg.com/news/2012-09-13  /yen-strengthens-asian-stocks-little-ch anged-before-fed-decision.html

You ask if QE III is new so lump together the extremely successful QE I with the extremely unsuccessful QE II. My view is that the FOMC is not like Apple and is like Coca Cola after they introduced new Coke. What they had to do was not find something new but go back to the old successful formula.

Posted by robertwaldmann | Report as abusive

I don’t agree with you on which difference between QE III and QE II is important. I think the key issue is that QE III is based on purchases of MBS not 7 year Treasury notes. The portfolio balance effects of purchases of assets which are considered risky (like MBS) is very different from the absense of such effect following the purchase of boring safe 7 year notes.

I think a preliminary assesment of the relative importance of portfolio balance and forward guidance is already possible. Forward guidance works through expected future short term rates, which should show up in medium and long term rates. The 10 year treasury rate fell 3 whole basis points on the announcement. I don’t see much of a forward guidance effect let alone much sign that it is bigger than earlier such effects, since the intervention is open ended.
In contrast “Mortgage-bond yields tumbled to unprecedented lows”. Sure looks to me like portfolio balance not forward guidance.

click the funny URL (old URL * new story = big rush)
http://www.bloomberg.com/news/2012-09-13  /yen-strengthens-asian-stocks-little-ch anged-before-fed-decision.html

You ask if QE III is new so lump together the extremely successful QE I with the extremely unsuccessful QE II. My view is that the FOMC is not like Apple and is like Coca Cola after they introduced new Coke. What they had to do was not find something new but go back to the old successful formula.

Posted by robertwaldmann | Report as abusive

I don’t agree with you on which difference between QE III and QE II is important. I think the key issue is that QE III is based on purchases of MBS not 7 year Treasury notes. The portfolio balance effects of purchases of assets which are considered risky (like MBS) is very different from the absense of such effect following the purchase of boring safe 7 year notes.

I think a preliminary assesment of the relative importance of portfolio balance and forward guidance is already possible. Forward guidance works through expected future short term rates, which should show up in medium and long term rates. The 10 year treasury rate fell 3 whole basis points on the announcement. I don’t see much of a forward guidance effect let alone much sign that it is bigger than earlier such effects, since the intervention is open ended.
In contrast “Mortgage-bond yields tumbled to unprecedented lows”. Sure looks to me like portfolio balance not forward guidance.

click the funny URL (old URL * new story = big rush)
http://www.bloomberg.com/news/2012-09-13  /yen-strengthens-asian-stocks-little-ch anged-before-fed-decision.html

You ask if QE III is new so lump together the extremely successful QE I with the extremely unsuccessful QE II. My view is that the FOMC is not like Apple and is like Coca Cola after they introduced new Coke. What they had to do was not find something new but go back to the old successful formula.

Posted by robertwaldmann | Report as abusive

I think you are dead wrong about the likely implications of QE3. This is the most important Fed Statement in my lifetime. For sure.

If you want to understand its likely implications, not that bond yields have already risen signficantly (a strong rebuke to those who believe that the Fed influences the economy through concrete steps), and more importantly, the stock markets love it.

If you want to understand how much the stock markets love it, look at the rebalancing into risk assets. Even in the UK, mining stocks have gone crazy on the firm expectation that this will lead to greater economic activity. That is the same reason that treasury yields are rising, and bank shares are up, presumably on the expectations that it will be easier to make money as the economy improves.

Today the Fed has seen the light, and the stock market is telling us that as a result the future path of GDP is at least a whole percentage point higher. And maybe more.

Posted by phil_20686 | Report as abusive

** wonders – why do I even bother tryin’ to post on the bug-infested blog site? **

@ phil20 – Happy days are here again, beside myself with joy I am. But wait, besides those things you listed – rising mining stocks, rising bond yields, rising bank stocks – there is one more you didn’t mention – crashing US$. If everyone was expecting the happy outcome you propose – why would investors be fleeing the US$? Logically, if your take is accurate, money should be flowing into the US, not out of it.

Seems more likely that fear of inflation/dollar-debasement has inspired markets to dump dollars and bonds and buy inflation-protected assets. I’m not sure entirely sure that’s cause for joy. And bank stocks – they’re rising because the Fed is about to take the toxic MBS stuff they’re holding off their books and on to the Fed’s – at a nice profit, most likely. I’m damn sure that’s no cause for joy to anyone but a banker.

Posted by MrRFox | Report as abusive

** wonders – why do I even bother tryin’ to post on the bug-infested blog site? **

@ phil20 – Happy days are here again, beside myself with joy I am. But wait, besides those things you listed – rising mining stocks, rising bond yields, rising bank stocks – there is one more you didn’t mention – crashing US$. If everyone was expecting the happy outcome you propose – why would investors be fleeing the US$? Logically, if your take is accurate, money should be flowing into the US, not out of it.

Seems more likely that fear of inflation/dollar-debasement has inspired markets to dump dollars and bonds and buy inflation-protected assets. I’m not entirely sure that’s cause for joy. And bank stocks – they’re rising because the Fed is about to take the toxic MBS stuff they’re holding off their books and on to the Fed’s – at a nice profit, most likely. I’m damn sure that’s no cause for joy to anyone but a banker.

Posted by MrRFox | Report as abusive

Two thoughts…

The dollar is crashing? Bond yields rising? Good! (Or at least less bad than the alternative.) The goal is to get economic activity restarted, not to keep the fat cats in cookies and cream. If the Fed has finally succeeded in generating an expectation of inflation, we may yet break out of this liquidity trap.

The biggest difference between QE3 and the previous programs may be in the lack of limitations invoked. Previously, the Fed announced, “Here’s some money, and we’ll take it back once inflation starts to pick up.” Now they are saying, “Here’s some money, and we’ll give you more next month, and more the month after that, and we’ll keep pushing money into the system until unemployment falls.” There is a HUGE difference between targeting inflation and targeting employment. This is closer to the NGDP target that people have been floating here for a few years.

Posted by TFF17 | Report as abusive

Could someone please explain something to me (in terms my room-temperature IQ can grasp, please) -

How does spending $40Bil a month to buy toxic MBS garbage off the books of banks and Agencies promote employment, or anything other than bank balance sheets and banker-bonuses?

Spending $40Bil on infrastructure I could see – gets real demand and employment and we get a finished-product that has social utility. ‘Course, it does nothing in particular for The Street, so I guess we scratch that approach.

Posted by MrRFox | Report as abusive

I haven’t seen the specifics, but I doubt they are buying “toxic MBS garbage”. They are likely buying agency-guaranteed debt, ultimately backed by the Treasury.

And ultimately it doesn’t matter what the Fed buys. If they buy existing securities, they push the investment capital back into the system. But they could buy rocks at $100/lb and it would have much the same effect. New money in the system, seeking a new landing pad. This is why stocks move higher in response to QE — the money has to go SOMEWHERE, and only a fool will compete for bonds at prices that the Fed is willing to accept (they have no profit motive).

End result:
(1) Capital goods (including stocks and real estate) push higher, or at least resist their natural tendency to decline in a bad economy.

(2) Inflation expectations pick up. This is why the bond market may paradoxically turn LOWER on this action. Makes the “hoarding” behavior that KenG talks about less attractive.

(3) The promise of low interest rates for an extended period of time MAY spur investment. If inflation picks up even a little, then holding Treasuries is likely to be a losing trade.

Spending $40B/month on infrastructure might be better. If the Treasury borrows and spends on infrastructure, you are creating new money (Treasury debt) and immediately dictating how it will be used (infrastructure spending). This program creates new money (since long-term MBS are not cash-equivalents) but doesn’t dictate how it will be spent. If it is plowed back into the trading of existing securities, then there isn’t any economic gain. But perhaps private enterprise will use some of it for real investing?

Unfortunately, spending on infrastructure requires the participation of Congress. Good luck getting that…

Posted by TFF | Report as abusive

I could buy your argument, TFF, if there was any evidence that capital is in short-supply in the market. As best I can deduce, capital is already excessively abundant – banks deposit it with the Fed right now, apparently because there are not enough trustworthy borrowers to absorb what they already have.

Even if there were such borrowers, why would I as a banker use my capital to earn the low interest rates that are on offer now when I can score much more by turning the cash over to my prop traders?

My guess, the banks use substantially all their QEIII bailout windfall for prop trading and more Fed deposits. Little or none of it goes for new loans to enterprises.

Posted by MrRFox | Report as abusive

The banks profit from the flow of money (and so they will profit from this), but they don’t hold the bulk of investment assets. The MBS being purchased will either come directly or indirectly from the assets of pension funds.

Prop trading activity has been shrinking and (under new regulations) will continue to shrink. That’s a bit of a red herring.

We agree that capital is already excessively abundant. So how do you encourage investors to actually put it to use? I know you detest inflation, and it doesn’t directly cure any ills, but perhaps in this situation the threat of inflation will convince people to **** or get off the pot?

QE3 isn’t terribly good for my personal situation. I’ve already seen my future investment returns evaporate. Now the Fed is guaranteeing (or trying to guarantee) that I will face a period of high inflation some time in the next half decade. I’m watching the future value of my savings fall. Meanwhile, my share of the national debt has gone up by $50k-$100k over the last few years.

But we’re all in deep doo-doo if the real economy and employment continue to slide, and Congress isn’t about to implement your (preferable) solution.

Posted by TFF | Report as abusive

@TFF – I don’t know what the preferred soultion is. I do have a pretty strong feeling that whatever it is, we’re not going to get it. IMO the people making the decisions care about enriching themselves and their ‘peers’, and no one else.

Inflation’s a bitch for those with savings. Rather than mess around with equity investments, much easier (‘specially for a non-US resident, but really anyone) to just get the hell out of the US$ by making overseas portfolio investments/deposits – only takes a mouse-click or two.

Posted by MrRFox | Report as abusive

As with all aging empires this one will weaken and falter. The knowledge is gone and replaced by politics and tricks. Once upon a time there was the potential that the capable and skilled would be rewarded. That is all gone now and everyone except the stupid know it. So only the stupid buy into the tricks of less than skilled manipulation class.

Posted by brotherkenny4 | Report as abusive

@MrRFox, this mess isn’t limited to the US.

As for my portfolio, I own quite a few foreign-based stocks and evaluate US-listed companies largely according to their ability to grow in the emerging economies. They may be “dollar based” investments, if they are listed on the NYSE, but that doesn’t much concern me if they are making most of their profits in other currencies.

Posted by TFF | Report as abusive

* BOJ extends its own asset purchases by another 10 trillion yen (admittedly not quite as much money as it sounds).

* The ECB has embarked on an “unlimited” asset purchase program.

* The Fed will be pushing $40B of new cash into the markets every month for the next forever.

What percentage of the world economy is conducted in those three currencies? Two thirds? Three quarters? This is a coordinated action by all the central banks to make cash cheap and hoarding expensive.

Also, while China might not be publicly jumping on this bandwagon, they will be buying enough foreign assets to keep their currency on par with their trade partners. They cannot and will not allow the yuan to appreciate substantially.

Posted by TFF | Report as abusive
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