Was quantitative easing a boost to housing or the economy?
Quantitative easing boosted the economy to the degree liquidity was a limitation; however, with debt deflation the real problem, QE didn’t accomplish much.
The federal reserve sets policy in meetings of the Federal Open Market Committee (FOMC), a group of bankers. The FOMC sets target interest rates and directs its traders to either buy or sell securities to meet interest rate targets. When the federal reserve buys Treasuries, the price goes up, and interest rates go down. When the federal reserve sells Treasuries, the price goes down, and interest rates go up.
Prior to the financial meltdown in 2008, the federal reserve only bought short-term Treasuries, but in an effort to rescue housing, they began what’s known as quantitative easing, an unprecedented campaign of buying 10-year Treasuries and mortgage-backed securities in order to drive down mortgage interest rates.
It’s important to remember that the federal reserve had never done anything like this before. However, with the member banks of the federal reserve exposed to a $1 trillion in unsecured mortgage debt at one time, stimulating housing to make prices go up was considered essential to save the banking system — or at very least preserve the jobs and bonuses of powerful banking executives.
The populace was sold on quantitative easing and mortgage interest rate stimulus as a measure to save “Main Street.” It was said this money pumped into the economy would create jobs, and the combination of jobs, increased incomes, and low mortgage rates would cause a boom in housing which would elevate loanowners above water.
What was sold as a big benefit to Main Street has instead devolved into another massive bailout of the banking industry with few tangible benefits to the people the programs were ostensibly designed to help out.
Proponents of these policies can point to the rapid increase in house prices over the last three years as a sign of success. While it’s true that many loanowners have emerged from beneath their debts, this policy wasn’t designed to keep them in their homes. The interest rate stimulus has merely elevated prices so when the terms of loan modifications increase borrower costs and push them out, the lender losses less money.
The policy of mortgage interest rate stimulus can only be characterized as a success from the perspective of a banker. Higher house prices are helping them recover more money from their bad bubble-era loans. Wouldn’t the real measure of success from the perspective of Main Street have people remain in their homes rather than simply improve the bank’s bad debt recovery?
And what about future buyers? They are being forced to pay bubble-era peak prices and endure a much higher cost of ownership. Is that a success for Main Street? It looks much more like a success for lenders. Not just do they recover more on their bad loans, they also get more interest income because they are making large loans to today’s homebuyers. It’s a win-win for the banks, but did quantitative easing really do anything for the economy or for housing?
The Federal Reserve is putting some of its post-crisis actions under a magnifying glass and not liking everything it sees.
In a white paper dissecting the U.S. central bank’s actions to stem the financial crisis in 2008 and 2009, Stephen D. Williamson, vice president of the St. Louis Fed, finds fault with three key policy tenets.
Specifically, he believes the zero interest rates in place since 2008 that were designed to spark good inflation actually have resulted in just the opposite.
I don’t think this is a good criticism. The headwind of debt deflation from the housing bust was simply too large to paper over. IMO, deflation would have been much worse without QE. So while we didn’t get much inflation, deflation wasn’t any worse.
And he believes the “forward guidance” the Fed has used to communicate its intentions has instead been a muddle of broken vows that has served only to confuse investors.
I think the federal reserve should stop pretending they are transparent. By making their internal deliberations public, they do confuse investors, and they also limit their own ability to react to data and changing conditions. Further, as they attempt to be transparent, they end up appearing less credible, more incompetent, and utterly impotent to effect the economy.
Finally, he asserts that quantitative easing, or the monthly debt purchases that swelled the central bank’s balance sheet past the $4.5 trillion mark, have at best a tenuous link to actual economic improvements.
Williamson is quick to acknowledge that then-Chairman Ben Bernanke’s Fed, through liquidity programs like the Term Auction Facility that injected cash into banks, “helped to assure that the Fed’s Great Depression errors were not repeated.”
Does he “acknowledge” this? The reporter is framing this supposition as a fact, and it’s not. (See: Bankster Bailouts Did NOT Save Us from the Second Great Depression)
But as for spurring inflation, reducing employment or otherwise generating sustained economic activity, the results, particularly for QE, are “at best best mixed.” In addition to muted inflation, gross domestic product has yet to eclipse 2.5 percent for any calendar year during the recovery, while wage gains, and consequently living standards, have been mired around 2 percent or less.
“There is no work, to my knowledge, that establishes a link from QE to the ultimate goals of the Fed—inflation and real economic activity. Indeed, casual evidence suggests that QE has been ineffective in increasing inflation,” Williamson wrote.”
For example, in spite of massive central bank asset purchases in the U.S., the Fed is currently falling short of its 2 percent inflation target,” he added. “Further, Switzerland and Japan, which have balance sheets that are much larger than that of the U.S., relative to GDP, have been experiencing very low inflation or deflation.”
The primary place where QE seems to have worked is in the stock market, where the S&P 500 has soared by 215 percent since the recession lows in March 2009. Elsewhere, though, deflation fears have permeated and interest rates have remained low.
Interestingly, one of the biggest fears Fed critics have espoused about its activities has been that the bloated balance sheet would drive inflation by releasing that “high-powered” money into the economy and driving up prices.
However, the inflation rate for the U.S., and for much of the other developed world where central bank activism is high, has remain muted, at least by conventional measures.
In Williamson’s view, that’s a product of policymakers wed to the Taylor rule, which dictates the level of interest rates in regard to economic conditions. The thinking essentially is that low rates beget low inflation, trapping central banks in zero interest rate policies (or ZIRP).”
With the nominal interest rate at zero for a long period of time, inflation is low, and the central banker reasons that maintaining ZIRP will eventually increase the inflation rate. But this never happens and, as long as the central banker adheres to a sufficiently aggressive Taylor rule, ZIRP will continue forever, and the central bank will fall short of its inflation target indefinitely,” Williamson said. “This idea seems to fit nicely with the recent observed behavior of the world’s central banks.”
The trap then manifests itself in a failed communication strategy.
In the third stage of QE, the Fed sought to establish specific targets for when it would raise rates, such as 6.5 percent unemployment rate and a 2.5 percent inflation target. However, as unemployment fell and inflation lagged, the Fed began moving the goalposts, to the point where the headline unemployment rate is now 5.3 percent and the central bank has yet to move on interest rates.
Williamson argues that the Fed is perhaps overdoing it with transparency. … Williamson wrote. “Thus, the Fed’s forward guidance experiments after the Great Recession would seem to have done more to sow confusion than to clarify the Fed’s policy rule.”
Many Wall Street strategists have issued forecasts expecting the Fed finally to end zero interest rates in September. However, uncertainty lingers: The CME’s FedWatch tool, which monitors futures contracts, indicates just a 36 percent chance of September tightening.
I’m still of the opinion that the federal reserve will not raise rates in 2015.
Why does the federal reserve manipulate interest rates?
The idea of a federal reserve and counter-cyclical interest rate policy emerged from observations on 19th century economic busts where the availability of capital to lend made the downturn much worse than it would have been if more capital were available.
In purely economic terms, mortgage interest rates should have skyrocketed in 2007 and 2008 when lenders realized risk was mis-priced. For as equity-crushing as the collapse in house prices was, can you imagine how bad it would have become if mortgage rates had risen to 12%? So much capital would have been removed from the system that no money would have been available to loan to anyone. Those savers with capital would have loved it as interest rates went sky high, but the economy would have suffered for a very long time. That’s the scenario the federal reserve is created to prevent.
The problem with a bust like the last one is that liquidity was not the problem. There was no shortage of money to lend.
The problem was insolvency. Nobody had the income to support the debts they already had. Insolvency is a much more serious problem than liquidity, and the federal reserve has only one tool to deal with it — ultra-low interest rates. They can make the marginally insolvent borrower solvent again by lowering their cost of debt, but that’s about it. Adding liquidity does nothing to improve the problem of insolvency. Potential borrowers need stable and expanding incomes, and they need to pay down the debts they already have. That takes time — a long time.
Perhaps the federal reserve will get it just right. Perhaps they will print money until deflation stops and then an improving economy will make continued printing unnecessary. People will go back to work, earn money, buy homes, and everyone will live happily ever after… or not.