The Corner

#QEDone, But Stimulus Remains

With these words, issued yesterday, the Fed ended its controversial “quantitative easing” program:

The Committee judges that there has been a substantial improvement in the outlook for the labor market since the inception of its current asset purchase program. Moreover, the Committee continues to see sufficient underlying strength in the broader economy to support ongoing progress toward maximum employment in a context of price stability. Accordingly, the Committee decided to conclude its asset purchase program this month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

Some background: After reducing its key short-term interest rate to zero nearly six years ago, the Fed began purchasing what ultimately amounted to trillions of dollars of longer-term securities in an effort to stimulate the economy by pushing down longer-term interest rates. This program — quantitative easing, or “QE” — has been extremely controversial, both among folks in politics and economists. Pretty much everyone now agrees that the QE program sent stocks soaring and reduced interest rates on government debt. But did those soaring stock prices help the broader economy through a “wealth effect”? Did QE help the housing market by lowering mortgage interest rates? Did it nudge corporations to create more jobs? Did its mere existence as a kind of signal of the Fed’s commitment to do whatever it could to boost employment stimulate the economy?

To answer these questions conclusively will require quite a bit of research, and my spider sense tells me that economists will be debating this for a long time. As for me, I’ve been a QE supporter. My opinion is that QE did help support the housing market, and it would take a lot of evidence to change my mind. I’d argue that QE helped other sectors, too, through some of the channels I mentioned above, but I’m more open to being convinced I’m wrong about its effect on non-housing-related economic activity.

Indeed, so controversial and confusing is QE that there is even a question as to whether the end of QE means a reduction in monetary stimulus. It is natural to think that it does. But what matters most, the size of the Fed’s balance sheet, the changes in the Fed’s holdings, or the signal the Fed was sending to market participants that it would go to great lengths to stimulate the economy?

If you believe that the size of balance sheet matters most — which the Fed does — then ending QE is not ending stimulus, but rather ending the Fed’s program of increasing the amount of stimulus it is providing. In other words, stimulus won’t turn to tightening until the Fed’s balance sheet starts to decline, which is still over a year away.

Justin Wolfers, an economist at the Peterson Institute and the University of Michigan, sees things that way.

The most important thing to understand about the Federal Reserve’s decision Wednesday is that it has decided to keep the monetary policy dial set to “stimulate.”

Indeed, by conventional measures, monetary policy is currently dialed in to as expansive a setting as it ever has been — not only in this recovery, but arguably in the history of the nation.

You can find Dr. Wolfers’s essay here, which he concludes by arguing, I think correctly:

But for all the hubbub about the decision to end quantitative easing, realize that the degree of monetary support the economy is receiving tomorrow will be no smaller than it was receiving yesterday.

This continued stimulus is welcome. I wrote a column earlier this month arguing that the Fed needed to continue to simulate the economy, despite the falling unemployment rate.

And then there’s the balance of risks. Let’s say I’m wrong about the unemployment rate but the Fed doesn’t increase rates faster and swifter. In this case, we’ll have some inflation. On the other hand, say that I’m right about the unemployment rate but the Fed tightens too quickly and too rapidly. In that case, a too-cool economy cools off even more, and millions of workers and potential workers who have been suffering for years have to wait even longer to return to full employment. And some surely won’t ever return.

A little inflation above the Fed’s preferred rate isn’t the end of the world — it’s a manageable problem, and may even be desirable. Letting millions of workers sit on the sidelines of the labor market is a bigger problem.

The fundamental logic of monetary policy is the same as it’s been for years now: Prices aren’t rising as rapidly as the Fed would like them to, and the labor market isn’t using workers to their fullest extent. The Fed is still missing on both sides of its “dual mandate.”

You can read my column here.

One final thought: The Fed, I think, thinks that QE was a success. So though it may have ended, don’t be surprised if the Fed pulls it off the shelf at some point in the future.

Let’s hope it isn’t needed again for decades to come.

— Michael R. Strain is a resident scholar and economist at the American Enterprise Institute. You can follow him on Twitter at twitter.com/MichaelRStrain.

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