Considering the magnitude, scope and history surrounding quantitative easing as a policy it’s no surprise that the action itself evokes intense emotion in many people. In this weekend’s reading, I saw the same few cliches repeated countless times to the point where I think the initial rationale has been lost. Before tackling these rhetorical, let me set the record straight on my personal thoughts re: QE2.
In short, while I think a stimulus based around an infrastructure build up would have been preferable, QE2 is a strong, important and effective action from the Federal Reserve Bank in shaping economic expectations. Many of the reactions I have come across ignore this emotive element to economics. Or even worse, they ignore the behavioral element in one domain and over-emphasize it in another for convenience. Economics are inherently emotional and I think the research is fairly conclusive and extensive on that fact at this point in time.
So with that being said, let’s take a look at the myths:
1. “It didn’t work the first time, so why would it work this time?”
This is perhaps the most oft-repeated and the most vulnerable to attack of the cliches. While it’s difficult to quantify what exactly “worked” means (i.e. do you have to be able to declare “Mission Accomplished” correctly at the end for success?), this statement succumbs to the fallacy that everything must be either black or white. Unfortunately reality is not so simple. In economics in particular, things don’t fit neatly into an either/or scenario and when you encounter such an either/or statements it’s typically from an ideologue of some kind. Be on alert, as ideology clouds reality.
Now let’s get to the facts. When the Fed announced the first round of quantitative easing on March 18 of 2009, that was one of the single biggest factors in making March 6th “the” bottom instead of “a” bottom. The openness of the Fed to the potential for easing leading up to the actual announcement itself helped convince the sideline cash to once again stat investing in American equities. Did it “work”? Well it depends what you’re looking for. Easing alone did not restore our economy to its trend growth rate, but it was a MAJOR factor in arresting the decline of all asset classes across the board.
Considering the scope of the decline in our economy, it’s simply impossible and unreasonable to expect one single policy to get everything back to normal, but it’s far from unreasonable to suggest that one policy helped more than any other in restoring some semblance of confidence in our future prospects. That one policy is/was quantitative easing.
Remember, in March of 2009 people were seriously concerned that this very recession would match or exceed the Great Depression in magnitude. The fear was palpable. People basically threw in the towel on our economy, economic models, etc. Meanwhile, within a mere three months of the inception quantitative easing, our economy officially exited recession and started expanding again.
2. “Quantitative easing punishes the savers, while helping those who were irresponsible.”
This is one of those classic critiques today of both quantitative easing and low interest rates. As the story goes, quantitative easing merely props up asset prices while leaving no low-risk options to generate a return. The idea is that no one likes to punish the good guy at the expense of the bad.
While it sounds great to make such an assertion, this statement fails to adequately reflect the nature of our economy over the past few decades. There are three serious reasons why this cliche falls on its face:
- First, our economy is where it is today because our society had too few savers. In aggregate, we took on far too much debt with far too little underlying growth. Who are these supposed savers? I’m sure there are a few here and there, but in reality, these savers were not nearly as abundant as the argument would have you believe. We were a nation of spenders.
- Second, there were in fact savers, but these savers didn’t just leave their money in bank accounts collecting interest. They were heavily invested in assets, including bonds and stocks. Many of these bonds were thought to be “risk-free” thanks to our ratings agencies, before they collapsed in value. At this point, supporting asset prices does as much to help savers as it does irresponsible spenders. So yes, we are helping rather than punishing savers.
- Lastly, in a deflationary environment, a 0% interest rate does generate a return for those leaving money in cash. If an aggregate price level is dropping at 2% on an annualized basis, that means cash returns 2% to its holder. The danger of deflation though is that it is risk-free to sit in cash, therefore why would anyone invest? That is exactly why the Fed wants to stimulate inflation.
3. “We’re just printing money…”
The argument goes something like this: when you change the quantity of money, you do nothing to change the underlying supply/demand in the economy, all you change is that what was worth $1 now is worth $0.50. In a vacuum, this statement holds some truth, but in reality the behavioral element of economics generates a very different response. Let me lead my response with an anecdotal argument and then get into the economics.
When a company splits its share price, no underlying fundamental dynamic changes in the business . Yet in the marketplace, stocks that split predominantly trade higher. This was as true in the days of Jesse Livermore as it is today. Why is that? Because people’s expectations and outlook change with a new price point. To some, a split is a sign of confidence from management in the underlying business, to some others a split brings the share price down to a more favorable level for investment, and to even more others its something completely different altogether.
What’s really significant about QE2 is how it already is shaping expectations for our economy. Just a quarter ago all the talk was about deflation and stagnant growth, while today that talk is once again about inflation. Investors are now operating under the assumption that the Fed will do anything possible to stimulate inflation in order to avoid another deflationary episode and the positive implications this change in expectation cannot be understated.
This leads to the second serious flaw in the above cliche, which is this idea that all we’re doing is destroying the dollar and paving the way for rampant inflation. What this argument does wrong is to attribute to today what happened yesterday. The Fed is embarking on QE2 now in order to cycle through yesterday’s excess growth of credit in the private sector. No chart highlights this fact more clearly than one from Steve Keen’s Minsky Model:
This chart shows both GDP alone and GDP+credit from 2000 to today. It’s clear from the evidence that much of the GDP growth over the decade preceding this economic crisis was due to credit expansion. i.e. There was little underlying real, organic economic growth, but there was much growth in credit. Such a credit expansion is in fact the printing of money, but in that context it’s done by the private, not public sector. What the Fed is doing today with QE2 is to help cycle that credit growth over the past 10 years through the economy today. Herein lies the reason why QE 1 did not in fact stimulate inflation, but did help restore investors’ appetites to put money to work. QE2 should help us take that next step.