Did QE2 work?

Having offered my assessment of the effects of the Fed’s second round of quantitative easing (QE2), I wanted to mention briefly the takes of some other observers.

Jeremy Siegel writes in today’s WSJ:

the rise in long-term Treasury rates does not signal that the Fed’s policy has backfired. It is a sign that the Fed’s policy is succeeding.

Long-term Treasury rates are influenced positively by economic growth– which encourages consumers to borrow in anticipation of higher incomes and causes firms to seek funds to expand capacity– and by inflationary expectations. Long-term Treasury rates are affected negatively by risk aversion: Seeking a safe haven, investors pile into Treasury bonds, running up their prices and lowering their yields.

The Fed’s QE2 program has raised expectations of growth and inflation, sending long-term Treasury rates up. It has also lowered risk aversion, which implies rising long-term rates. The evidence for a decline in risk aversion among investors is the shrinkage in the spreads between Treasury and other fixed-income securities, the strong performance of the stock market, and the decline in VIX, the indicator of future stock-market volatility. This means that expectations of accelerating economic growth—and a reduction in the fear of a double-dip recession—are the driving forces behind the rise in rates.

Others interpreting the rise in Treasury yields as an encouraging indicator include David Beckworth, Ryan Avent, Cardiff Garcia, and David Andolfatto.

John Cochrane, on the other hand, sees little good about QE2:

All that quantitative easing (QE) does is to restructure the maturity of US government debt in private hands. Now, of all the stories you’ve heard why unemployment is stubbornly high, how plausible is this: “The main problem is the maturity structure of debt. If only Treasury had issued $600 billion more bills and not all these 5 year notes, unemployment wouldn’t be so high. It’s a good thing the Fed can undo this mistake.”

Of course that’s preposterous. The banking system is awash in liquidity. Banks used to hold about $2 billion dollars of excess reserves. Now, they have about a trillion. If they didn’t lend out this first trillion of extra cash, why would they lend the next $600 billion?

I agree with John that the primary effects of QE2 come from restructuring the maturity of government debt, and that any effects one claims for such a move are necessarily modest. But unlike John, I believe those modest effects are potentially helpful.

Just to reiterate, my position is that when you combine the Fed’s actions with the Treasury’s, the net effect has been a lengthening rather than shortening of the maturity structure:

given the modest size, pace, and focus of QE2, and given the size and pace at which the Treasury has been issuing long-term debt, the announced QE2 would have been associated with a move in the maturity structure of the opposite direction from that analyzed in our original research. The effects of the combined actions by the Treasury and the Fed would be to increase rather than decrease long-term interest rates.

Did QE2 work?

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