Part one in a two-part blog series discussing quantitative easing measures on a domestic and global scale.
As policy rates hover near (or below) zero, the focus has been on the timing and magnitude of rate hikes by the Fed and other central banks. Don’t worry, I’m not here to add my speculative voice to that crowded discussion. Instead, I want to provide a quick ex-post assessment of another tool that has left the spotlight after being largely phased out by the Fed. I’m talking about quantitative easing (QE)—the buying of massive amounts of financial assets—or large-scale asset purchases (LSAPs) as they are termed by some economists.
At its core, QE attempts to influence the supply and demand for financial assets, thereby shifting preferences towards spending and investment and away from saving. (For those interested in getting further into the weeds on QE’s theoretical underpinnings, check out Ben Bernanke’s 2012 Jackson Hole speech, Jeremy Stein’s remarks that same year, or this release by the IMF.) Among the U.S., U.K., Japan, and the ECB, the scope of QE to date has amounted to around 10-20% of 2014 nominal GDP. To put that into perspective for the U.S.’s case, that is about the magnitude of U.S. total federal discretionary spending over the trailing four years.
So, with the Bank of Japan and ECB contemplating expanding quantitative easing at their upcoming meetings, does the existing research generally conclude that QE globally has been a few trillion dollars well spent? Let’s take a closer look.
LSAPs have seemed to benefit U.S. equities unequivocally well, and international equities less so. Evidence on financial system vitality is mixed.
The algebraic explanation is relatively straightforward: the yield on risk-free securities is an element of the discount rate used to value stocks and other assets. Artificially keeping this rate low, as well as creating expectations that it will stay that way, increases the discounted present value of other financial assets. However, only in the U.S. has the annualized return of that country’s respective MSCI index over the past five years exceeded the return required by a general equity risk premium of 5.57% (from Fama & French, 2002) and country risk premiums as computed by Aswatch Damodaran of NYU (2015).
Evidence on QE’s ability to reduce stress within the financial system is mixed. Event studies show that QE announcements were followed by sharp reductions in financial stress indicators, which consist of variables including the TED spread, corporate bond spreads, and beta of banking stocks. However, some studies on Japan’s experience with QE assert that it took a substantial amount of time for bank lending to improve, as banks were burdened by nonperforming loans and uneasiness towards extending credit.
Furthermore, QE may have also distorted asset prices (some have gone far enough to use the term bond bubble) while creating “price-insensitive buyers,” a term used by Ben Inker of GMO to describe an investor for whom the expected return on the asset does not dictate their decision to purchase.
Look for part two of this blog series later in the week.
The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Holdings are subject to change.