QE2 After Three Months

Here’s what Tyler Cowen had to say back on November 10th, a week after QE2 was announced:

I’m unhappy with claims that ”we’re not doing enough” and that therefore this is no test of the idea of monetary stimulus.  This is what QEII looks like, filtered through the American system of political checks and balances.  And if it looks small, compared to the size of our problems, well, monetary policy almost always looks small compared to its potential effects.  I’m willing to consider this a dispositive test and I am very curious to see the results.

Is it too soon to see the results of this “dispositive test?”  In one sense it’s far too late.  Monetary policy should target NGDP growth expectations, and we saw in the run-up to QE2 that growth expectations were rising rapidly on hints of QE2.  We don’t have NGDP futures markets, but based on things like stock and commodity prices, and TIPS market inflation expectation, I’d guess expected NGDP growth for 2011 rose from around 3.5% to 4.0% in August to around 5.0% to 5.5% in November.  At the time I argued that this was quite good news, although we actually needed about twice as much monetary stimulus.  Unfortunately, I’m just about the only person in the world (with the possible exception of Robin Hanson) who evaluates macro policy on that basis.  Most want to see how it plays out in the real world.

Some would argue it is too early to see the effects in the real world, citing “long and variable lags” in monetary policy.  As you know, I don’t entirely buy the lag argument.  I think it reflected misidentification of monetary shocks by the monetarists (and Keynesians as well.)  And the asset markets seem to agree with me.  For instance, when policy was very volatile during the 1930s, monetary shocks led to movements in asset prices that were highly correlated with contemporaneous movements in industrial production.  That shouldn’t happen with long and variable lags.

Of course there is a distributed lag, as output such as the construction of new office buildings requires careful planning.  Asset prices respond immediately to monetary shocks, whereas some types of output respond almost immediately, but the peak impact may be many months out into the future.  So we don’t have enough data yet to see the peak impact.  Here’s what we do know; starting with bad news, then the good news:

Bad news:

1. Real and nominal GDP growth was disappointing in 2010:4.  The media called the 3.2% RGDP growth a slightly positive development, but the 3.5% NGDP growth was very disappointing.
2. The payroll numbers have been disappointing; although it’s possible the snowstorms impacted the data.

Good news:

1. The final sales number (both real and nominal) was quite strong, somewhere around 7% in 2010:4.  The real number was the strongest since the 1980s.
2. The unemployment rate fell by 0.8 percentage points in the two months after QE2 was announced, the sharpest two month fall since 1958.  As with the payroll number, there are questions about the accuracy of this data.
3. The ISM manufacturing activity number for January was the highest since 2004.
4. The ISM manufacturing employment number for January was the highest since 1973.
5. The ISM exports number for January matched May 2010, and was otherwise the highest since 1988.
6. The ISM services number for January showed the fastest growth since August 2005.

My hunch is that the truth is somewhere between the two extremes, and we are still on course for 5.0% to 5.5% NGDP growth.  BTW, NGDP growth (or nominal final sales growth) is of course the only test of the efficacy of monetary stimulus at the zero bound.  RGDP growth is useful for a different question; to decide whether stimulus of any kind was needed.  If the NGDP growth is mostly inflation and not much RGDP growth, it would suggest that neither monetary nor fiscal stimulus was appropriate, rather labor market and tax reforms would have been called for.  So far the data shows mostly real output gains, and relatively low inflation.

Please remind me to do this test about every three months.  I may forget because I don’t think it is important.  I already know the only answer that matters to me.  But it is obviously important in terms of how the rest of the world will evaluate the ideas we quasi-monetarists have been peddling for the last few years.  So far so good; keep your fingers crossed.

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