Detour to QE
This website and blog was set up to explore potential drivers of discontinuities in the global economy, mainly around the five “big trends” described in more detail in the website. That’s still the intention. However, after years of quantitative easing (QE) and with its imminent end, in fits and starts, I am dedicating a series of blogs to exploring whether QE’s end could fuel discontinuities. Some, including me, could argue the case that QE’s end will be as uneventful as its start. But, it might not be, and its effects might also not have been as mild as many of us presume. I want to explore those possibilities here, partly in retrospect and partly looking towards the future.
When QE was proposed, a group of prominent economists wrote an open letter to the Wall Street Journal that it would debase the currency and cause inflation. They were wrong, and their wrongness reflects an unfortunate reality that economists often talk about money without understanding the financial system. QE was, and was designed to be, asset inflationary. To be CPI inflationary would require clear channels from asset to consumer markets. There are very few, with most blocked in normal times in “normal” economies. When an institution sells an asset to a central bank under QE, they use the proceeds to buy other assets, increasing demand in the asset markets where the purchases are made. They don’t go out and buy cars and meals and other stuff that would increase demand, and the CPI, in consumer markets. That’s embezzlement under most circumstances. There are a handful of channels through which increased QE demand in asset markets could get into consumer markets, but few are very compelling.
Let’s leave this point aside for a moment for a more current topic. What was the economic effect of QE? The short answer is we don’t know for sure. That’s too bad because the answer would help in understanding the end of QE (not to mention the nearly inevitable future rounds of it). There are lots of ideas, but in truth there is no set of theoretical or empirical tools that will definitively tell us whether QE did or did not cause lower unemployment, higher incomes, and increased GDP. However, we can poke around for some ideas, using this same exploration of channels within which money moves through the financial system.
QE is designed to drive asset inflation and decreased yields in a range of longer-term monetary instruments. In fact, yields on corporate bonds, medium to long term government bonds, and other instruments reached historic lows. Success! That’s basic supply and demand. Did this change in rates stimulate the economy? Again, the question is related to the structure of the financial system. There are different channels through which interest rates can affect an economy. Not all operate at any point in time, effect the economy in the same direction, or work the same during periods of increasing and decreasing rates. The site http://effectofinterestrates.com/ lays out some of the main channels, and these and others will help in considering what we might see as QE peaks and wanes.
This entry sets the backdrop for some topics to come:
- The channels that were open and closed during QE in the last ten years that would allow lower rates on interest bearing assets to translate into greater wage, employment and/or output growth
- The channels that were closed that may have kept QE from achieving broader economic goals
- The effects of QE ultimately, both on economic growth and on the economy and financial system more widely
- What might happen when QE is “tapered,” or unwound, and how markets, politicians, and central banks might react, if at all
- When does QE become “helicopter money,” especially as it becomes perceived as permanent or quasi permanent. This is a fun topic and I am not sure how long I can wait to get into it.