By James Saft
Jan 16 Well, now we know: monetary policy
certainly isn't rocket science.
Asked on Thursday if he was confident before implementing
quantitative easing that it would work, outgoing Federal Reserve
Chairman Ben Bernanke quipped:
"The problem with QE is that it works in practice, but it
doesn't work in theory."
Seriously, imagine a NASA official after a moon shot joking
that the booster rockets had worked in practice but not in
theory. Think of the looks he might get from the astronauts
standing alongside him.
Now, of course, Bernanke should be permitted one joke per
four-year term, and he did go on to say that the Fed's use of QE
was grounded in practical experience from Japan and elsewhere as
well as theoretical underpinnings from academia.
After years of the Fed engaging massively in QE, consensus
about its effects is far stronger in terms of its effect on
financial markets, where it is viewed as an electronic form of
Viagra, than on the actual economy.
Bernanke went on to say that most research on asset
purchases has suggested that "while there are differences in
views about how effective QE is, the great majority of studies
have found that (rounds of QE) are at least somewhat effective".
"At least somewhat effective". Not what you want on your
tombstone, though for many of us it is no more than the truth.
Bernanke's joke was referring, in part, to a paper delivered
at the same meeting by his colleague from the San Francisco Fed,
John Williams, which opened by quoting the old joke that "An
economist is a man who, when he finds something works in
practice, wonders if it works in theory." ()
Much depends on your definition of "practice", "theory" and
"works", especially the last.
THEORY AND PRACTICE
As Williams explains, there are two basic theories as to the
mechanism through which QE should, in theory, work.
The first broad idea posits that financial markets are
frictionless (i.e. populated by profit-maximizing robots), and
that therefore QE won't have an impact on asset prices,
inflation or output, but merely serves as a kind of semaphore
through which the central bank can signal its longer-term
intentions about interest rates. For those of you willing to
entertain the idea of a frictionless financial market, I refer
you to the Facebook IPO, or if you must, to any bar at about 11
PM on a Thursday near any large financial exchange. 'Nuff said.
The second idea, acknowledging that financial markets are
populated by people with conflicting interpretations of their
own best interest, supposes that QE drives asset prices higher
by forcing investors in safer assets out of their usual
"Two themes emerge from this research on the effects of
asset purchases on asset prices. First, although individual
estimates differ, this analysis consistently finds that asset
purchases have sizable effects on yields on longer-term
securities," Williams writes.
"Second, there remains a great deal of uncertainty about the
magnitude of these effects and their impact on the overall
First, the easy part. Yes, QE drives financial markets.
Williams reviews 15 studies and finds that the central tendency,
or consensus, is that $600 billion of asset purchases lowers the
yield on 10-year Treasury notes by 15 to 25 basis
That is significant, and indeed consensus is that QE has had
a generally positive effect on financial assets. It is also safe
to say that, as a direct effect of QE, this asset price
inflation has directly benefited financial intermediaries, a
segment of the economy which is arguably overgrown anyway.
Also, because the rich tend to own financial assets and
others tend not to, QE generally fueled wealth inequality.
Now, as to that real economy. One study found that QE2, the
$600 billion program launched in 2011, shaved a quarter of a
percentage point off of unemployment. Another is less
What does seem clear is that if QE is having an impact it is
doing so through the wealth effect, as people spend part of
their stock market gains, rather than by encouraging investment,
which remains low compared to corporate profitability.
So, what does all this mean now that QE is being withdrawn?
In some ways the implications are comforting. If QE didn't
help the economy all that much, perhaps QE going away won't hurt
all that much.
Unless you own financial assets. Then you are looking at a
withdrawal of a support at a time when inflation is seemingly
intractably low and the economy, all these years later, not
Easy come, easy go.