Felix Salmon

The case against QE

Felix Salmon
Nov 15, 2010 16:12 UTC

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.


@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

Is QE2 already working?

Felix Salmon
Nov 15, 2010 14:29 UTC

Bloomberg’s Liz McCormick has an interesting take on QE: “Options Showing Quantitative Easing Working Before It Begins” is the headline on her piece, which concentrates on an obscure indicator known as “payer skew.”

Payer skew is an indicator which goes up when bond yields are rising, and goes down when they’re falling. When payer skew is high, as it is now, it’s an indication that markets see more risk that bond yields are going to continue to rise than they see risk that yields will fall.

But it’s a stretch, I think, to conclude that the rise in payer skew means that QE is working. And it certainly can’t be working before it even begins. After all, QE2 has already begun, with the purchase on Friday of more than $6 billion in bonds maturing between 2014 and 2016.

It seems to me that what we’re seeing in the payer skew numbers is the downside of QE, rather than its intended consequence. The stated aim of QE, after all, is to bring down long-term interest rates, and that isn’t happening at all:

Yields on 10-year Treasuries, a benchmark for everything from corporate bonds to mortgage rates rose last week by the most since December, surging 26 basis points, or 0.26 percentage point, to 2.79 percent.

Meanwhile, the problem with QE is that it maximizes the amount of volatility, uncertainty, and tail risk in the markets generally and the bond market in particular. Since businesses invest when they have certainty about the future business environment, QE risks exacerbating the very problem that it’s intended to solve.

My take, then, on the payer skew figures is that they’re an indicator of increased risk and nervousness in the bond markets. While traders don’t yet expect higher inflation outright, the demand for hedge against falling bond prices is definitely rising. There’s nothing here to encourage businesses to take out long-term loans and invest the proceeds in new permanent jobs.

So I can’t imagine that anybody on the FOMC is looking at the rising payer skew numbers as an indicator that QE is working. After all, the ultimate aim of QE is to create jobs. And I can’t think of a single reason why higher payer skew means more job creation.


Isn’t the goal of QE to jump-start the economy by bringing down long-term *real* rates? And isn’t the expectation that it will do so by increasing inflation? After all, when there is deflation with low nominal rates, that is a high real rate.

And as payer skew is about nominal rates, this seems to be working as intended, if it is a strong signal at all.

Posted by jmalicki | Report as abusive