Current use of Q.E. in U.S. and the decision to implement QEII:
Whereas the decision of the Bank of Japan to implement their quantitative easing policy was more a result of fundamental problems which had afflicted the Japanese economy for an extended period of time, the decision by the United States Federal Reserve to undertake similar policy actions was motivated by rapid global economic decline. For the United States, the implementation of the Federal Reserve’s quantitative easing programs occurred during two distinctive periods, known as “QE1” and “QE2”. The first round of quantitative easing, QE1, lasted from December 2008 until March 2010, and employed a three point attack on the stagnant economy which focused on increasing liquidity both inside and outside of the banking sector, as well as easing economy wide credit by lowering a wide range of interest rates.
To fulfill their first objective, the Fed established the Term Auction Facility, or TAF, in an effort to expand access to money in their lender of last resort role. TAF worked by using an anonymous auction system to lend funds to banks, domestic only at first, and then to international banks as well later on.[1] To increase liquidity outside the banking sector, the Fed was authorized to purchase up to $200 billion of asset-backed securities. Finally, to impact the yield on longer-term assets, the Fed bought $600 billion of debt and mortgage-backed paper held by federal agencies as well as long-term Treasuries. By the end of the program, the Fed purchased $1.7 trillion of Treasury and mortgage-backed securities. Economists at the Federal Reserve Bank of New York estimate that these Treasury purchases resulted in a drop of half a percentage point on longer-term Treasury yields.[2] Yet despite the progress made on Treasury yields, mortgages and loans remained difficult to qualify for and expensive to obtain, and the benchmarks of the Fed’s dual mandate targeting unemployment and inflation both lagged, with unemployment around 9.6% for the period and the inflation rate lower than the generally accepted target between 1.7% and 2%.[3]
While the first round of quantitative easing worked toward accomplishing a number of goals set by the Fed, such as the lowering of longer-term yields, in the face of heightened unemployment levels, as well as the fear of persistent deflation, the Federal Reserve announced in November 2010 a second round of easing, or “QE2.” In contrast to the more expansive and diverse actions taken by the Fed during QE1, the QE2 program focused solely on the purchase of longer-termed government securities, much like the Bank of England’s program. Over an eight month period ending in June 2011, the Federal Reserve committed to purchasing $75 billion of Treasury securities, primarily ones with maturities of two to ten years, averaging to around five or six years.[4] By June of 2011, the Fed had bought $600 billion worth of Treasuries in an effort continue the downward pressure on longer-termed yields. After the initial announcement of QE2, riskier and higher-yielding assets experienced an upward jolt as the lower yields on longer-term securities pushed investors into riskier assets with the promise of higher returns. Yet while this initial surge in prices seemed to signify the success of QE2, the true impact on the U.S. economy remains questionable, especially regarding employment levels.
As commodity, specifically energy, prices shot up, consumers spent less on non-energy expenditures and firms, which would hypothetically be more willing to undertake long-term investment projects due to the ease in credit, were faced with higher production costs. The result has been a significant slowdown within the economy as the previously spiked asset prices have retreated.[5] Stephen Jen, partner at the SLJ Partners hedge fund, reasoned that there would “be a few weeks of positive reaction, followed by a sell-off, as investors realize the circular and pointless logic of the argument that QE2 could lead to permanent increases in economic activities”.[6] Daniel Thornton, Vice President of the Federal Reserve Bank of St. Louis, predicted the fact “that analysis suggested several reasons why QE2 might have little or no effect on output, or employment,” as well as cautioning that further Treasury purchases could cause “unprofitable lending due to interest rates at or below the cost of capital, thereby encouraging banks to hold excess reserves rather than make loans”.[7]
While in the short term it appeared that the program of Treasury purchases proscribed by QE2 would have a positive impact on the economy, it now appears that the gains in asset prices were artificially inflated, and eventually undermined by high commodity prices. Additionally, given the role the dollar has in emerging economies where currencies are largely pegged to the dollar or held to a tight exchange rate, QE2 not only risked inflating commodity prices, but prices in emerging economies as well.[8] Though a primary cause of concern within the United States, deflation, seems to no longer to be a major possibility, the inflationary pressures caused by this second round of quantitative easing on both commodity prices and within the emerging economies, as well as the continued stagnancy of the economy, suggests that the program cannot be qualified as successful. Even the effect the program had on flattening the yield curve has done little to improve overall investment levels and lending and borrowing remains tight within the economy. This lack of response amongst lenders and borrowers seems to signify that given the general uncertainty experienced by businesses, both from future growth prospects as well as regulatory increases, lowering the cost of long-term debt financing alone will not stimulate economic investment. In this way, Federal Reserve action can have a positive impact on the economic recovery, yet the complexity of the economic and political issues within the country can greatly mitigate the impact of policy actions. By realizing these limitations and potential obstacles in policy effectiveness, along with the negative effects on consumption due to the inflated prices of commodities, it becomes apparent that despite the fact that this round of quantitative easing properly targeted the fundamental issues of the economy, the real results of the policy illustrates that it was not a good decision.
[1] See Klyuev et al.
[2] See Reddy.
[3] See Reddy
[4] See Reddy.
[5] Waki, Natsuko. “Analysis: QE3 May Do More Harm than Good| Reuters.” Business & Financial News. Reuters, 27 July 2011. Web. 8 Nov. 2011.
[6] See Waki.
[7] Thornton, Daniel L. “The Downside of Quantitative Easing.” Economic Synopses. Federal Reserve Bank of St. Louis, 10 Nov. 2010. Web. 30 Oct. 2011.
[8] See Waki.
