Has Quantitative Easing Worked? A Two-Part Blog Series Perspective (Part II)

Solomon-(2)Brad Solomon, Junior Investment Analyst

Part two in a two-part blog series discussing quantitative easing measures on a domestic and global scale. Part one published last week.

Transmission to Main Street has been dubious.

The Fed’s FRB/US model, which is the workhorse behind quantifying QE’s transmission mechanisms into the general economy, forecasted a 0.2 percentage-point drop in unemployment over a 2-year time horizon as a result of a $500 billion LSAP, according to then-Fed governor Stein in 2012. Given that the cumulative scale of QE in the U.S. totaled around $4 trillion over about 4.4 years, excluding intermittent periods between buying sprees, the FRB/US model would then forecast a reduction in unemployment of 1.6 percentage points. (This assumes that there are no marginally diminishing returns to QE dollars.) Building in a “lag” of six months, the actual U.S. unemployment rate fell by 4.0 percentage points during this period and currently hovers near 5%, right above what is often pegged as the natural rate of unemployment. To what extent that reduction is due to QE, though, is very difficult to answer—there is no “control subject” in real-world experiments. The next-best-option is the event study that looks at variables prior to and following some stimulus, although this risks blending the effect with some other variable. While unemployment has fallen near its natural rate, anecdotal evidence speaks to widespread underemployment

Other metrics look either ambiguous or decidedly impressive. Across the U.S., U.K., Eurozone, and Japan, industrial production growth has been significantly more volatile than it was pre-recession; unemployment has fallen, with exception of the Eurozone where it has marched further upward after a double-dip recession in 2013; household saving as a percent of disposable income has come down substantially. Lack of healthy inflation has proven to be the fly in the ointment. Nearly 30 countries have explicitly adopted inflation targeting (around half of those in the last 15 years), but the majority continue to be plagued by nagging disinflation or outright deflation. Consider the poster child Japan who pioneered QE over the 2001-2006 period in its commitment to purchase $3-6 trillion in Japanese government bonds (JGBs) per month until core CPI became “stably above zero.” While the Bank of Japan wrapped up with the program in March 2006 after witnessing year-over-year core CPI in Japan clock in just above zero for three consecutive months, this was more of a mathematical win. Headline inflation over the period picked up solely due to a rapid rise in the price of crude oil, which arguably has little connection to monetary policy. This is not to say that some commentators have not already called for an indefinite deflationary environment, or that QE’s effects on the money supply don’t appear ambiguous.

Getting back to using the U.S. as an example, income growth has not followed the drop in unemployment, and inequality has persisted. Annualized growth rates since 2010 have been near zero and well below their long-term averages, and the lack of growth is particularly pronounced in the lower income quintiles.

Solomon_QE_4

On another front, record-low mortgage rates are undoubtedly a product of QE but have not translated into pre-2008 home buying, even in the presence of rising FICO scores and real home prices that are hovering around their 10-year trailing average. In fairness to QE, though, there simply seems to be a lack of a relationship between the cost of borrowing money to buy a home, and the demand for borrowing that money, as evidenced by the chart below.

Solomon_QE_5

QE’s efficacy seems to have varied case-by-case, and there is a growing consensus that there are diminishing marginal returns to QE.

Of this last point, Japan and the ECB should take note. While the Bank of Japan refrained from expanding its QE program at its meeting this past Friday above the current $670 billion p.a. rate, such expansion remains on the table for its November and December meetings. A similar decision faces the ECB in December, and the rhetoric of ECB President Mario Draghi has been mostly dovish in tone. (The annual rate of asset purchases by the ECB currently stands at about $816 billion.) While both banks will ultimately adhere to their mandates in trying to combat deflation and negative export growth, perhaps expectations should be set low for how effective further QE will be in meeting those mandates.

Proponents of real business cycle theory would not be surprised at much of the above—that is, that aggressive monetary policy has failed to override a general shift in appetites for home-buying, tepid supply-glut disinflation, reduced appetite by banks to lend, and the preference by businesses towards doing nothing productive with bond issuance besides repurchasing their own equity. These “exogenous” factors may overpower the stimulatory nature of QE, or the problem may be one of model specification. (Getting back to the home sales/mortgage rate example, QE may do its job of lowering borrowing rates, but this may not ultimately stoke home-buying appetites, which is a failure of the assumed indirect transmission mechanism that underlies QE’s founding.) Whatever the case, while it has helped solve short-run liquidity problems by injecting cash into the financial system, QE has proven sub-optimal in terms of being a cure-all to the woe of general economic lethargy.

Further reading

  1. Fawley, Brett & Christopher Neely. “Four Stories of Quantitative Easing.” (2013)
  2. Krishnamurthy, Arvind & Annette Vissing-Jorgensen. “The Ins and Outs of LSAPs.” (2013)
  3. Klyuev, Vladimir et. al. “Unconventional Choices for Unconventional Times.” (2009)
  4. McTeer, Robert. “Why Quantitative Easing May Not Work the Same Way in Europe as in the U.S.” (2015)
  5. Raab, Carolin et. al. “Large-Scale Asset Purchases by Central Banks II: Empirical Evidence.” (2015)
  6. Schuman, Michael. “Does QE Work? Ask Japan.” (2010)
  7. Stein, Jeremy. “Evaluating Large-Scale Asset Purchases.” (2012)
  8. Williams, John. “Monetary Policy at the Zero Lower Bound.” (2014)
  9. Williamson, Stephen D. “Current Federal Reserve Policy Under the Lens of Economic History.” (2015)
  10. Yardeni, Edward & Mali Quintana. “Global Economic Briefing: Central Bank Balance Sheets.” (2015)

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. Brinker Capital, Inc., a Registered Investment Advisor.