This is not my last words on the subject, but these are some of my initial thoughts on QE3. From The Economist:
Earlier this year, the Federal Reserve reached a crossroads. It had lowered short-term interest rates to zero and promised to keep them there until 2013, and then 2014. It had undertaken multiple rounds of bond purchases to lower long-term interest rates. Yet the recovery was actually losing steam; unemployment had stopped falling. Was there anything left to try?
The answer, it turns out, is yes. The Fed made one of its most consequential announcements yet today. The detailed actions were, in themselves, similar to previous steps: it will buy $40 billion of mortgage backed securities per month, and extend the period of short-term rates near zero until at least mid-2015. But the game changer was what it said: it will keep buying bonds until, and beyond, when the recovery is firmly established.
All other attempts have failed and now the Fed is reaching for the kitchen sink. Despite my cynicism, this is certainly a victory for market monetarists throughout the blogosphere. They have argued that money has been too tight over the past couple of years and it now seems that the Federal Open Market Committee agrees with them.
However, I must emphasize the “seems”. I myself look at this as less an intellectual victory for the market monetarists and more of a correlation between what the FOMC is now willing to do and their own beliefs. The market monetarists could have won the intellectual debate in 2008 and yet I do not think that the course of monetary policy would have changed. What we now see is less of a paradigm-shift in policy than a reflexive reaching towards bigger guns after the smaller ones failed to do the job.
That gives me a very Japanese feeling about all of this. Just as in Japan, for better or for worse, it is events that are leading the Federal Reserve down policy routes rather than its choice of policy determining the events that affect it. That alone gives cause for pessimism.
Another problem, one that I wrote about before, is that the Federal Reserve has no means of committing itself to this policy. What gives people reason to believe that the Fed will actually abide by what it says today? Especially with the racketing up of Fed policy each year, it is a very good bet that when recovery does not come this year, that the FOMC will reach for an even bigger gun next year. Scott Sumner over at The Money Illusion may want the Fed to abide by results-based policies rather than basing its policies on tools like loosening credit. However, the Federal Reserve cannot simply will a recovery into existence. This in turn must leave us wondering what will happen when a strong recovery doesn’t happen over the coming year, and I have a feeling that the FOMC will simply continue its reaction to events by ratcheting up its policies.
Without commitment, words are wind. The only way that the Federal Reserve could truly commit itself to NGDP in a manner I see affecting expectations across the entire economy is by law. Either the Federal Reserve is completely willing to target NGDP, or it is not. If the former, then it would be willing to have that be legislated and would want Congress to legislate that in order to send the strongest signal possible. If not, well then I see this as simply a case of trying out a new policy and then being willing to leave it by the wayside if things don’t go well.
Another feature of the announcement that provides cause for pessimism is the decision of the FOMC to buy mortgage-backed securities. This to me will provide incentives that will hamper what must happen if the economy is to truly recover from the havoc of 2008: resources that were misdirected under the bubbly conditions of the boom must be reallocated to more productive uses. There simply will not be any recovery worth having. It’s not a matter of simply how many Legos we have, it’s a matter of how well those Legos fit together and whether anything can be done with them.
I do not know where recovery will come from, what will be the next big jump in productivity that expands the American recovery (though many have estimated that the new iPhone 5 alone may contribute 0.5% to GDP growth this year). However, it will not come from housing. Don’t get me wrong, I believe there are places in the country in which the housing market is strong and will continue to be strong, but there are other places where we must accept that much of the market must be liquidated. This has largely been done, but housing policies and the purchase of mortgage-backed securities work against this aspect of the recovery.
On top of all of that, this policy comes four years too late. It certainly would have been an improvement over the initial round of Quantitative Easing and would have fought the decline in Nominal GDP over that period. It still would not have been enough to prevent this terrible economy, though, for this economy is not a problem of too tight money, but a problem of massive malinvestments, an economy that was too leveraged and that thought it was richer than it really was.
NGDP over the yeays, note the collapse in 2008.
That would have been four years ago. Today it may very well be a move in the right direction, but it will have nowhere near the decisive effect proponents of NGDP targeting hope for. Nor should the necessity of NGPD targeting in face of economic downturns be the lesson of what we now experience. Instead, the lessons should be about the real side of the economy.
It was not the money illusion that created 2008 nor is it the money illusion that will raise the world from its economic malaise. Let that be known.
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