QE: A View from the Trenches

Several people have asked me to comment on a new WSJ article by Andrew Huszar, who managed the Fed’s bond-buying program:

It wasn’t long before my old doubts resurfaced. Despite the Fed’s rhetoric, my program wasn’t helping to make credit any more accessible for the average American. The banks were only issuing fewer and fewer loans. More insidiously, whatever credit they were extending wasn’t getting much cheaper. QE may have been driving down the wholesale cost for banks to make loans, but Wall Street was pocketing most of the extra cash.

The Fed should not be trying to affect the supply of credit or the price of credit, so I’m glad to hear that it didn’t seem to have those effects.  The goal should be to stabilize the growth rate of NGDP.

From the trenches, several other Fed managers also began voicing the concern that QE wasn’t working as planned. Our warnings fell on deaf ears. In the past, Fed leaders—even if they ultimately erred—would have worried obsessively about the costs versus the benefits of any major initiative. Now the only obsession seemed to be with the newest survey of financial-market expectations or the latest in-person feedback from Wall Street’s leading bankers and hedge-fund managers. Sorry, U.S. taxpayer.

Huszar doesn’t seem to realize that financial-market reactions are the best indication of how these programs are working, indeed the only reliable indication. Everything else (such as borrowing costs) is meaningless without a counterfactual.

Trading for the first round of QE ended on March 31, 2010.  .  .  .

You’d think the Fed would have finally stopped to question the wisdom of QE. Think again. Only a few months later—after a 14% drop in the U.S. stock market and renewed weakening in the banking sector—the Fed announced a new round of bond buying: QE2. Germany’s finance minister, Wolfgang Schäuble, immediately called the decision “clueless.”

If you are going to criticize Fed policy, you really ought not mention any eurozone policymakers, especially German policymakers.  The Germans were the ones pressing the ECB to adopt a tighter monetary policy. How did that work out?  Well back in 2009 and 2010 the eurozone and the US had almost identical unemployment rates (close to 10%).  Since then the eurozone rate has risen to 12.2% while the US rate has fallen to 7.3%.  And what explains that vast difference in performance?  Mostly differences in NGDP growth, i.e. monetary policy.

And what explains the difference in monetary policy?  The Fed was doing one QE after another, with the avowed intention of boosting aggregate demand.  The ECB was raising short term interest rates in 2011 with the intention of reducing aggregate demand.  Both “succeeded.”

It’s certainly fair to point out that the US recovery has been weak, despite QE. But if you are going to criticize QE you need a counterfactual policy.  What should the Fed have done to boost NGDP growth? Huszar doesn’t say.  Quoting eurozone hawks isn’t going to convince anyone outside the WSJ editorial page, over on this side of the pond.  FWIW, I would have preferred NGDPLT and elimination of IOR, as an alternative to QE.

The article contains a lot of discussion about how QE is a subsidy to banks. There’s s tiny bit of truth in that claim, as the Fed does pay 0.25% interest on reserves.  And they should not do so.  But the $5 billion or so that flows to the banking industry via QE is peanuts compared to the $100 billion the Feds are taking from banks through extortion.

Others argue that low interest rates are a subsidy to banks, which makes no sense.  Interest rates are set in the free market.  Back in the old days when central banks did tight money the progressives cried that it was a subsidy to big bankers.  Now when the Fed does “easy money” progressives and many conservatives cry that it is a subsidy to big bankers.  Neither is a subsidy.

And the impact? Even by the Fed’s sunniest calculations, aggressive QE over five years has generated only a few percentage points of U.S. growth. By contrast, experts outside the Fed, such as Mohammed El Erian at the Pimco investment firm, suggest that the Fed may have created and spent over $4 trillion for a total return of as little as 0.25% of GDP (i.e., a mere $40 billion bump in U.S. economic output). Both of those estimates indicate that QE isn’t really working.

Actually if the bump is only $40 billion then QE is working.  Huszar makes the mistake of assuming the “cost” is the amount of bonds purchased.  But that’s not a sensible definition of cost, as the Fed is simply swapping one government liability for another.  A better measure of cost is the interest on reserves program, which has cost about $5 billion per year on average.  And even that is an exaggeration; earnings on the Fed’s bond portfolio offset it.  BTW, “a few percentage points” might be a million jobs, or more. Does Huszar think unemployment is not a big problem?

And how is Mr. El Erian an “expert” on the macroeconomic impact of QE?  What model does he use? Where does his expertise come from? When I went to grad school we were never taught how to model a QE/IOR program.  Did he study how to model these programs in grad school?  If so, which one?  I’m not trying to pick on Mr. El Erian, who I don’t know, my point is that it is not at all clear where one would get expertise in this area.  It’s very possible that El Erian knows more about QE than anyone else in the world, but is still not an expert.

In my view there is only one expert—the market.

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