Posted by: Dirk | September 21, 2012

QE3: effective policy or last push on a string?

The latest round of QE3 is now playing out on financial markets worldwide. The idea is that the FED buys up some illiquid assets in return for fresh funds which would allow banks to lend more. If short-term interest rates are close to zero already, longer-term interest rates can be targeted. All this should be expansionary, creating a higher expectation of inflation in the future. This part seems to have worked, as the FT reports:

Bond investors pushed a key measure of US inflation expectations on Monday to their highest level since 2006, in response to last week’s aggressive policy action by the Federal Reserve.

Market expectations for US inflation over the next 10 years rose as high as 2.73 per cent on Monday, based on the difference or the so-called “break-even rate” between nominal and inflation-protected Treasury debt.

Now for the transmission mechanism. Lower interest rates should increase investment, coming to think of it, perhaps even consumption. Households are struggling with debt still, so the latter is quite unrealistic. On the former there is a survey from Duke University. They asked businessmen directly about their decisions:

U.S. finance chiefs say that interest rate reductions of 1 or 2 percentage points would not alter their capital spending plans, indicating that potential monetary policy actions by the Federal Reserve are unlikely to spur the corporate sector to action.

OK, so much for that. Here is my reading of the situation. Apparently, some market participants are (still) believing that quantitative easing is expansionary. Hence they speculate on rising prices, thus driving inflation expectations upward. However, there will be a Wile E. Coyote moment when they collectively understand that they have gone over the cliff. When, nobody knows. It probably will have something to do with bad, really bad data from the real economy which shows that demand is falling. Less demand equals less output, and when the demand from the real economy for primary products is not made up by speculative demand financed by debt prices will adjust. All of this will happen in an environment of very low interest rates, which is not stimulating economic activity.

This, of course, is just my opinion. With the limited experience we have, I think that quantitative easing is a policy that indicates that something is wrong in your economy. I do not believe that besides buying some time it “works” in any fundamental way on the real economy. Japan in its slump tried both quantitative easing and fiscal stimulus, and it turned out that the latter was much more effective. I have not seen any serious theory or argument which would explain why it would be different in the US (or euro zone or …). The wording chosen by Chairman of the Fed Ben Bernanke did not help either. For those who missed them, I have summarized his remarks and translated them into Orwellian NEWSPEAK:

times 13.9.12 bb speech qe3 prolefeed

economy doubleplusungood, no undark on the edge. FOMC will act speedwise. MBS goodbuy programme will pluslower postmedium-term interest rate. BB will monitor you.



  1. Only a complementing remark: Eggertson and Woodford (2003), of course besides others, show nicely that what your are saing could already be seen in our New Keynesian Models when modified properly.
    I think what you are saying is quite true. I would not expect that QE of the form we have seen is reaching the real economy and I would also say that inflation scares as they are built up in Europe right now are often overstated. With the latest release of the Ifo-index just today my picture of QE was confirmed.
    Still, it will be interesting to observe housing prices in Europe…

    • You are quite right. It is over fiscal policy where I would see the differences between SFC models of the type presented in Lavoie/Godley (2006) – which are in my mind, roughly – and NK models. An increase in government spending (not an increase of the size of the government sector) would be beneficial for the economy only according to the former. The main intellectual division is the role of money, and I see a lot of empirical support for endogenous money theories while those that used money supply+multiplier analysis have been consistently wrong. The M1 money multiplier has been below one for some years now in the US, which should make you wonder.

  2. […] and the 10-Year Treasury Inflation-Indexed Security, Constant Maturity (DFII10). Even though QE 3 has just been announced, that picture does not scream hyperinflation, does […]

  3. QE might give temporary relief but eventually will lead to higher inflation, making life more miserable for those who earn less. Fiscal stimulus can accelerate economic growth with the condition of spending less and taxing those who are considered elite in the economy meaning thereby fiscal consolidation with moderation – nor too fast nor too slow..

  4. […] I have discussed QE on this blog before (September 2012): […]

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