A quick response to this guest post by Gerard Macdonell on Noah Smith’s blog.
There are two main thrusts to the post.
One is that the stated claims for the efficacy of QE are false. I’m not a fan of QE myself, and concur on some points, but I think the event study analysis is more persuasive than he does.
Second, Gerard assumes that the Fed’s move reveals that it really believes QE to be ineffective. I disagree on that entirely.
Actually, I’m pretty sure that the reason that the Fed has raised rates without QE sales first is exactly the reason they stated, and also strategised in private.
That is that they don’t want QE to be the marginal instrument of monetary policy.
The plan is, and was, to begin QE sales when it was felt that there was enough clearance of interest rates over the zero bound such that, if the economy began to worsen, this could be dealt with using interest rates only. This plan would avoid having to restart QE purchases. Conducting QE sales and then reversing course would complicate debt management policy, and, said the operational analysts, generate uncertainty in the securities market itself.
Think about it: if the Fed really thought that QE asset stocks were not doing anything, they would surely be getting rid of them as fast as possible, as they have generated political hostility, and selling would be a costless way of eliminating the criticisms that come from the conservative permahawk lobby who perceive a tail risk in the form of a large surge in inflation on account of the extra money printed.
If you thought that only flows of QE mattered, but not stocks, then that would also be a motive for following the current Fed strategy, and so would rationalise Gerard’s interpretation of the Fed’s behaviour. But in this case you have to believe in a watertight conspiracy to fail to explain the real reasons behind policy, participated in by all the voting and non-voting FOMC members, and avoiding leaks from disappointed staff.
Gerard thinks that if the Fed did still believe in the efficacy of QE, there would be far too much stimulus out there, bearing in mind that the Fed has told us rates won’t rise either fast or far. However, this flies somewhat in the face of facts. Although unemployment continues to fall in the US, there is credible evidence that there is ‘missing unemployment’ in the form of those outside the labour force who want to enter it and will, so Gerard’s claim that the US is close to ‘full employment’ is controversial. And the Fed’s preferred inflation measure is weak, provoking the ire of Summers and co who think that the Fed’s rise in rates is premature anyway. The data provide a pretty good case for there not being too much stimulus out there now.
Gerard also highlights what he thinks is an economic error in his thinking, what he deduces is a ‘misapplication of the quantity theory’. He cites this passage from a 1999 paper.
“The general argument that the monetary authorities can increase aggregate demand and prices, even if the nominal interest rate is zero, is as follows: Money, unlike other forms of government debt, pays zero interest and has infinite maturity. The monetary authorities can issue as much money as they like. Hence, if the price level were truly independent of money issuance, then the monetary authorities could use the money they create to acquire indefinite quantities of goods and assets. This is manifestly impossible in equilibrium. Therefore, money issuance must ultimately raise the price level, even if nominal interest rates are bounded at zero. This is an elementary argument, but, as we will see, it is quite corrosive of claims of monetary impotence.”
The ‘misapplication’ Gerard homes in on is the statement that money ‘has infinite maturity’. I read him as wanting to dispute that in the case that the economy turns out to need, subsequently, a reversal of the QE operation that created the increment to money. But this simply misreads what Bernanke meant by ‘infinite maturity’. What he meant, I have no doubt, was that there was nothing contractual in the ‘contract’ that the money embodies that triggers a future settlement of money in the form of something else at any particular date.
However, in pointing this out, we do get into territory where this passage raises some theoretical and policy issues of some controversy. I don’t fully grasp what is bugging Gerard, but it might have something to do with the following, which recaps material briefly I have gone over before.
This gets to something that is actually ambiguous, though not necessarily incorrect, in Bernanke’s text.
In the standard model of money and finance, issuing more money will stimulate prices even at the zero bound if this issuance corresponds to a lowering in expected future rates. If, on the other hand, expected future rates are already as low as possible, this won’t happen. In the standard model, money is treated as a liability like bonds. And so indefinite unlimited issuance is not possible or consistent with fiscal promises. If attempted, agents believe that they will be reversed at some point, and there is no stimulus.
Policy makers have sometimes pointed to the fact that, in practice, money is not, or not considered a liability of anyone. So its issuance [leaving aside the detail of interest on reserves] doesn’t create a liability. Willem Buiter has a paper that formalises this logic. In these circumstances, money issuance stimulates regardless of whether interest rates are expected to be at the zero bound forever or not.
For central bank historians interested in Bernanke rune-reading, the potential ambiguity in Bernanke’s text quoted above is this: It’s not clear whether he means that money should not be included as a liability in infinite horizon consolidated central bank/government budget constraint, or whether he just means that money does not fall due at some particular date. If he meant the latter, then his statement is only true, theoretically, if future rates are not currently expected to be zero forever. If he meant the former, then what Bernanke said is true regardless.
I say ‘regardless’: this I’m just surveying two classes of non-micro-founded money models here. Whether it’s true in micro-founded models, I don’t know. And whether it’s true in the real world is anyone’s guess!
Thanks, Tony, for your thoughtful commentary on my post.
I have written a lot on this by now and don’t want to repeat myself too much or get sucked into a discussion of what models imply, as my take on this is not largely about models. It is not so much that I reject models as that I am not competent to comment on them!
But I have just a few points to offer in response to your own thoughts. First, I guess I have the opposite take from yours as regards the efficacy and desirability of QE. I actually supported QE, but am just pretty sure it did not operate as indicated on the label. I must correct myself if I left the impression I have a hawkish take. I am convinced by Summers’ arguments for erring on the side of making the mistake that is most easily fixed.
I just don’t think it is likely that the Fed would be in a position of promising not to sell down the balance sheet AND “promising” not to raise interest very quickly if it believed QE were providing much stimulus. But as you say, maybe there are huge headwinds so that we need all the (presumed) stimulus from QE AND the stimulus from low rates. And maybe there is a lot more slack in the labor market than the Fed leadership is claiming. It is certainly possible, but it just does not seem to be the most likely or simplest explanation. Also, as you might say, it relies on the “conspiracy” view that they are lying about their take of the labor market. (Incidentally, I think you are totally right that they don’t want QE to be a “marginal” policy instrument. I would put it differently, as they would not value the distraction, but I agree on the main point.)
As for the efficacy of QE, I think it works in large part via symbolism. You say that it may be the flow that matters, which I do think the Fed believes. That is CONSISTENT with the view that QE works via its symbolism and INCONSISTENT with the portfolio balance channel asserted when QE was introduced.
QE operates also as a form of rates signaling, as you mention. What would work even better as a form of rates signaling would be explicit rates signaling, which the Fed seemed to demonstrate — if that is not too strong a word — by maintaining its rates signal even after it wound up QE purchases. The money where their mouth is argument has some plausibility, but it has not been demonstrated and is at odds with the Maturity Extension program, because the maturities there were much longer than the Fed’s intended rates signal.
Regarding, Bernanke’s Original Sin, I am not sure how I could have been clearer. Excess reserves that pay a market rate of interest and whose creation is explicitly orthogonal to the inflation objective, which has been made exogenous, just are not money. I doubt you want to get into a semantics debate, but I mean they are not money in the sense that Bernanke implied in his original motivation of LSAPs back in 1999. This is really fundamental. If I am wrong about it, then I am wrong in half my argument.
Finally, you are more convinced by event studies than I am. Maybe you are right to be so, but your appeal to your own authority is unconvincing. Those announcement effects seemingly had a nasty tendency to get reversed. Indeed, in his book, Bernanke addresses this, but claims that the reversal was “seen” as evidence of the success of QE, presumably in acting on expectations for growth and inflation. I “see” them as evidence that supply disturbances matter more in the short run than in the long run, because people learn. I am Bloomberg-less at the moment and therefore cannot demonstrate it. But if you can take a look at the effect of, I think it was, QE2 on MAGPI, BoA’s measure of the prospective excess returns in mortgages. I was very round trippy.
Again,thanks for commenting. I find this subject fun, although just an up and down economist.
Thanks for the reply. A lot to think about. Interesting to meet [at least on the internet] my polar opposite, ie a QE supporter that turned negative on the idea. I agree with many of your sceptical notes about the impact studies. In fact, to add another point in this direction, even if the impact did turn out to be durable, it’s not altogether clear that that would constitute a benefit.
Polar opposite, eh? I had to bail on my old job when the consultants came in and said, so deeply, that Polaris will not always be polar. Seriously, where I was that was considered relevant, like QE. Or so pretended the powers that be. The powers that be are actually brilliant but under pressure.
I like you. I accept that you have the higher IQ.
I am biased by the following experience. I had a “macro dinner” with a sell side chop shop featuring the patriotic and wonderful Brian Sack as a speaker. It was 2012 or abouts. He trotted out the segmented markets / portfolio balance argument. He also said he was the biggest hedge fund manager in the world, charging zero and .0000001.
But to a man — they were all men — nobody remotely internalized it. They thought that QE was money printing and that here was a Fed guy saying QE mattered and that therefore they were right. They were not right and were unanimous in being wrong. As the bald guy says in The Hangover, that sh@t sticks with you.
Thanks to Noah for getting me the opportunity to share with you.
For more of my dumb ramblings, try beinnbhiorach.com. It is a hill in Nova Scotia. The pronunciation is Ben Veerich and it is probably The Road To Rankin’s Point.
Good tale. Hey, I am not taking that high IQ thing. Your post was very deep and careful and I’m still wrestling with it. I note that both Steve Williamson and John Cochrane liked it a lot.