The Board of Governors of the Federal Reserve
(the Fed) launched its program of Large-Scale Asset Purchases (LSAP), referred
to in the popular press as “Quantitative Easing,” on 25 November 2008, in
response to the recession that began in December 2007. Through this program,
the Fed planned to purchase $800 billion worth of bank debt, mortgage-backed
securities, and Treasury bonds. By the end of the program, in June 2010, the
Fed had actually purchased a total of $2.525 trillion of these securities and longer-term
Treasury debt. The Fed initially ended this purchase program in June 2010
because the economy looked to be in recovery. In August 2010, the Fed began to
purchase $30 billion in long-term Treasury debt per month because the recovery
began to slow. This extraordinary monetary policy was deemed necessary because
the Fed had already exhausted its normal policy tools, such as lowering the
Federal Funds Rate (FFR), which was nearly zero (Amadeo, What Is Quantitative Easing?, 2013).
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| Figure 1: Ex-post Inflation in 2010 |
In November 2010, The Fed announced that it
would buy $600 billion of Treasury debt, in order to keep its portfolio at
approximately $2 trillion (Amadeo, Federal Reserve's QE2, 2012). The stated
purpose of this additional LSAP (“QE2”) was to increase inflation, which had
been falling steadily throughout 2010, and was threatening to fall below zero
(Figure 1). With the announcement, inflation expectations (University of
Michigan Inflation Expectation) immediately began to rise, with measured
inflation (Core PCE) ceasing to fall, and beginning to rise in early 2011
(Figure 2). The growth rate of Real GDP, which had begun to fall off in the
second quarter of 2010, has remained above one percent since the implementation
of QE2 (Figure 3). While this is hardly encouraging, based on recent history
(Figure 4), QE2 likely headed off another recession.
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| Figure 2: Recent Expected Inflation and Ex-post Inflation |
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| Figure 3: Recent GDP Growth |
In order to assess whether or not LSAP should
have been discontinued in the fourth quarter of 2010, it is necessary to weigh
the net benefits and costs of continued LSAP. The benefits include bolstered
inflation and GDP, and reduced unemployment. The potential costs include
runaway inflation and reduced purchasing power of the dollar internationally. I
will weigh each of these, and demonstrate both that there existed no compelling
reason to discontinue LSAP in 2010 and that no macroeconomic event since 2010
has altered this calculus.
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| Figure 4: Historical GDP Growth |
The chief criticism of LSAP broadly is that it
is likely to lead to a drop in value of the dollar (Macroeconomic
Analysis).
Bill Gross, manager of PIMCO, the world’s largest mutual fund, voiced this
concern specifically in the run up to the announcement of QE2. "When a
central bank prints trillions of dollars of checks, which is not necessarily
what (a second round of quantitative easing) will do in terms of the amount,
but if it gets into that territory --- that is a debasement of the dollar in
terms of the supply of dollars on a global basis" (Ablan, 2010).
The trade-weighted dollar index (major currencies and broad) was in the middle
of a slight decline when QE2 was announced, and bottomed out six months later.
It has risen for the most part since (Figure 5).
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| Figure 5: World Purchasing Power of the Dollar |
Daniel Thornton, Vice President of the Federal
Reserve Bank of St. Louis, warned in late 2010 that the then-recently announced
QE2 posed a “danger [of] long-run inflation … well above” the 2% target (Thornton, 2010). Inflation expectations, as
measured by the University of Michigan survey and the 5- and 10-year TIPS
spreads, have been between 1.5 and 3.8 percent, while actual measured
inflation, as noted above, has hardly risen above 2 percent (Figure 2). David
Andolfatto recently noted that TIPS-spread-based measures of expected inflation
have begun to move upward, but that the effect is more prominent on short-run
expectations than on long-run (Andolfatto, 2014).
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| Figure 2: Recent Expected Inflation and Ex-post Inflation |
Thornton also warned that “additional quantitative
easing may have only modest effects on economic growth, employment, or inflation”
(Thornton, 2010). In contrast, Cúrdia and Ferrero
examined the effects of QE2 on GDP growth and inflation and found that QE2 led
to a 0.13 percentage point increase real GDP growth and a 0.03 percentage point
increase in inflation. This effect owes much to the effectiveness of “forward
guidance,” or clearer communication of Fed policy intentions (Cúrdia & Ferrero, 2013). Matthew D. Raskin
also found a positive economic effect of this move toward clearer communication
(Raskin, 2013). The analysis by Cúrdia and
Ferrero led them to conclude that a reduction of the FFR of 0.25 would have a
more reliably positive impact on these metrics, but, as the FFR was near zero
at this time, as it has been since late 2008, such a policy option was
unavailable.
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| Figure 6: Recent Deviations From Potential |
Another argument in favor of accommodative
monetary policy is that the US economy has been operating significantly below
potential since mid-2008 (Figure 6). Real GDP has not been below potential to
this degree in thirty years (Figure 7). Reifschneider, Wascher, and Wilcox
estimate (with a more pessimistic measure of potential GDP) that the US economy
is currently 7% below potential as of 2013 (Reifschneider, Wascher, & Wilcox, 2013). The
supply-side damage from the crisis includes labor-market inefficiency, reduced
labor-force participation and capital stock, lower multifactor productivity.
This is the source of their measure of potential GDP, which is below that of
the Congressional Budget Office, but still markedly higher than real GDP.
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| Figure 7: Historical Deviations From Potential |
In any macroeconomic analysis, counterfactuals
are exceedingly difficult. True laboratory experiments are nearly always
impossible. When available, natural experiments can prove very valuable. None
of these methods are possible in the analysis of something as large,
unprecedented, and deeply interwoven with both the wider macroeconomy and
specific financial markets as LSAP. The analyses of Cúrdia
& Ferrero, Raskin, and Reifschneider, et al. attempt to quantify specific
effects of LSAP, and these analyses can form the basis for complex
counterfactuals that will likely inform the papers of economic historians for
decades to come.
Ultimately, the best technique to
determine whether the Fed should have discontinued LSAP in late 2010 is simple
benefit-cost analysis. Since the worst of the dire predictions about QE2 and
beyond have not come to fruition, and show no sign of doing so going forward,
and since the scaling back of asset purchases has not yet disrupted markets,
and also shows no sign of doing so in the medium-term, and since there is still
clearly much slack remaining in the economy, due in no small part to
counterproductive fiscal policy due to political intransigence, it is
impossible to conclude that it would have been wise for the Fed to discontinue
LSAP in the fourth quarter of 2010.
Works Cited
Ablan, J.
(2010, November 1). Fed easing may mean 20 percent dollar drop: Gross.
Retrieved January 20, 2014, from Reuters:
http://www.reuters.com/article/2010/11/01/us-pimco-gross-idUSTRE6A055R20101101
Amadeo, K.
(2012, December 12). Federal Reserve's QE2. Retrieved January 20, 2014,
from About.com: http://useconomy.about.com/od/Fed/g/QE2.htm
Amadeo, K.
(2013, December 30). What Is Quantitative Easing? Retrieved January 20,
2014, from About.com: useconomy.about.com/od/glossary/g/Quantitative-Easing.htm
Andolfatto,
D. (2014, January 17). U.S. Inflation Expectations: Low, But Rising.
Retrieved January 20, 2014, from MacroMania:
http://andolfatto.blogspot.com/2014/01/us-inflation-expectations-low-but-rising.html
Cúrdia, V.,
& Ferrero, A. (2013, August 12). How Stimulatory Are Large-Scale Asset
Purchases? Retrieved January 20, 2014, from Federal Reserve Bank of San
Francisco:
http://www.frbsf.org/economic-research/publications/economic-letter/2013/august/large-scale-asset-purchase-stimulus-interest-rate/
Federal
Reserve Bank of St. Louis. (2014, January 20). [All Figures]. Retrieved
January 20, 2014, from Economic Research: http://research.stlouisfed.org/
Macroeconomic
Analysis. (n.d.). Criticism of Quantitative Easing. Retrieved January
20, 2014, from Macroeconomic Analysis: http://macroeconomicanalysis.com/macroeconomics-wikipedia/criticism-quantitative-easing/
Raskin, M.
D. (2013, May 9). The Effects of the Federal Reserve’s Date-Based Forward
Guidance. Retrieved January 20, 2014, from Board of Governors of the
Federal Reserve System:
http://www.federalreserve.gov/pubs/feds/2013/201337/201337pap.pdf
Reifschneider,
D., Wascher, W., & Wilcox, D. (2013, November 21). Aggregate Supply in
the United States: Recent Developments and Implications for the Conduct of
Monetary Policy. Retrieved January 20, 2014, from Board of Governors of the
Federal Reserve System: http://www.federalreserve.gov/pubs/feds/2013/201377/201377pap.pdf
Thornton, D.
L. (2010). The Downside of Quantitative Easing. Retrieved January 20,
2014, from Federal Reserve Bank of St. Louis - Economic Synopses:
http://research.stlouisfed.org/publications/es/10/ES1034.pdf
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