EconoMonitor

QE3 and beyond

Now that we’ve closed the books on 2012, I thought it might be useful to take a look at where monetary policy has led us over the last four years.

The fireworks began when the collapse of Lehman Brothers in September 2008 led to a freezing of credit for all kinds of essential economic activities. The Fed stepped in with a number of emergency lending programs such as the Commercial Paper Lending Facility to help the commercial paper market continue to function, currency swaps to assist foreign central banks cope with emergency dollar needs, and the Term Auction Facility to provide direct liquidity to U.S. banks. These programs totaled over $1.7 trillion at the end of 2008, but have since all been wound down. The Fed came out of it all making a profit that was returned to the U.S. Treasury.

 

The need for these facilities began to ease in 2009, but the economy was far from healthy, with unemployment continuing to shoot up. This led to the Fed’s decision in March 2009 to replace the emergency lending with large-scale purchases of mortgage-backed securities guaranteed by Government Sponsored Enterprises (the light yellow region in the graph below) and to a lesser extent long-term U.S. Treasury securities (light blue). These purchases were popularly described in the financial press as the first round of quantitative easing, or QE1. Their effect was to keep the total value of assets held by the Federal Reserve from falling as the emergency lending programs declined.

 

Although the recession officially ended in June of 2009, the recovery proved to be disappointingly weak. In November of 2010, the Fed committed to a new round of long-term Treasury purchases in what became known as QE2. This shows up as a second growth phase in Fed assets in the graph above, which brought Fed assets up to $2.9 trillion by June 2011. A third growth phase (QE3, consisting of ongoing purchases of more MBS) began last September, as a result of which Fed assets should move above $3 trillion for the first time this month.

Why is the Fed doing this? Congress has given the Fed a dual mandate, instructing it to help the economy achieve maximum employment while maintaining price stability. There should not be much argument that we are still a long way from the first objective. The unemployment rate currently is at 7.7%, quite high by historical standards. At the most recent FOMC meeting, the Fed signaled that QE3 purchases the low fed funds rate will continue as long as the unemployment rate remains above 6.5% and inflation below 2.5%. [Note Dave Altig's correction to my original wording.]

 

A key reason for the sluggish recovery is that, unlike other historical recessions, housing failed to make a positive contribution to GDP growth during the first three years of the current recovery. This is of course related to the fact that the Fed and other regulators let the housing boom get out of control in the earlier part of the decade. Nevertheless, getting the construction sector back to work is critical for the U.S. economy to fire on all cylinders. The Fed’s hope has been that by keeping mortgage borrowing costs low, QE1-QE3 may have given some boost to still-depressed sectors like housing. And in the latest data, we’re finally seeing some initial signs of that long-awaited recovery.

 

The second part of the Fed’s dual mandate is controlling inflation. The Fed paid for QE1-QE3 by crediting the accounts of the banks that sold it assets with new funds in their accounts known as reserves. Banks could, if they wished, ask the Fed to redeem these reserves in the form of green currency delivered in armored trucks. But so far, currency held by the public has increased very little as a result of these operations. Contrary to popular impression, the Fed has not been “printing money like crazy.” Instead, banks have so far been content to end each day holding a huge volume of reserve deposits in their accounts with the Fed, as seen in the graph below of the liability side of the Fed’s balance sheet.

 

And how much inflation has all this produced so far? Very little, according to the consumer price index, which is up only 1.8% from last year.

 

To be sure, the CPI is not without its flaws, among other concerns being its treatment of housing costs. But the separate inflation measure from the Bureau of Economic Analysis based on actual purchases of consumption goods and services shows only 1.4% inflation over the last 12 months.

 

Those who insist that no government statistics are to be believed may prefer instead the Billion Prices Project run out of MIT, which comes up with an inflation measure based on prices of goods marketed on the internet. This index tells exactly the same story as the government statistics.


Or you could look at what the Survey of Professional Forecasters expects for the years ahead. Answer– more of the same.

Median Short-Run and Long-Run Projections for Inflation (Annualized Percentage Points)
Headline CPI
Core CPI
Headline PCE
Core PCE
Previous
Current
Previous
Current
Previous
Current
Previous
Current
Quarterly
2012:Q4
2.0
2.3
2.0
1.8
2.0
2.0
1.8
1.6
2013:Q1
2.1
2.1
2.0
1.9
2.0
1.8
1.9
1.8
2013:Q2
2.1
2.2
2.0
2.0
2.0
2.0
2.0
1.9
2013:Q3
2.2
2.2
2.1
2.0
2.1
2.0
2.0
1.9
2013:Q4
N.A.
2.3
N.A.
2.0
N.A.
2.1
N.A.
1.9
Q4/Q4 Annual Averages
2012
1.8
1.9
2.2
2.0
1.7
1.7
1.9
1.7
2013
2.2
2.2
2.0
2.0
2.0
2.0
2.0
1.9
2014
2.3
2.3
2.2
2.2
2.2
2.2
2.0
2.0
Long-Term Annual Averages
2012-2016
2.20
2.28
N.A.
N.A.
2.00
2.00
N.A.
N.A.
2012-2021
2.35
2.30
N.A.
N.A.
2.20
2.10
N.A.
N.A.


I also like Paul Krugman’s suggested inflation measure– the change over time in the dollar price for a one-year subscription to Shadowstats. Six years ago, it would cost you $175 to get a one-year subscription. For 2013, Shadowstats is offering a one year subscription for … $175.

Managing a $3 trillion balance sheet may prove to be more of a challenge for the Fed once conditions finally begin to improve. But based on what has been seen in the data so far, an objective observer would have to conclude that, when evaluated in terms of the Fed’s legislative mandate, QE1-QE3 have helped a little in terms of the employment goal and done no harm in terms of inflation.

This piece is cross-posted from Econbrowser with permission.

2 Responses to “QE3 and beyond”

evodevoJanuary 13th, 2013 at 10:39 am

All the various QE programs have done is hold off the GD II, and prop up insolvent bank balance sheets. As far as the housing market "recovery", all I see locally is "investors" buying up foreclosed properties to rent or flip, along with the occasional retail buyer finally trading up, after being in a hold pattern for 5 years. The frenzy of 2003-6 is long past, was obviously unsustainable, and housing will not recover to those levels for decades, if ever. Most people have much less money because of lower salaries, (People got no jobs, no money, as Charlie Pierce says) and won't spend. Many I know are being MUCH more prudent fiscally than they were in the early aughts, due to job uncertainty (you may have one now, but who knows about tomorrow), and the knock-on effects from this to the greater economy are continuing. The last 30 years of job outsourcing have come home to roost and the chickens aren't leaving any time soon. There will be no "inflation" as we think of it (Weimar?) till everyone has a job and a salary hike.

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