QE2 Trashing Trifecta: Peter Orszag Joins Gross and Grantham

Tyler Durden's picture

The president's own former advisor, and now very much outspoken critic, Peter Orszag has joined the cool kids by releasing the following scathing oped in the NYT, whose topic is, drumroll, QE2: "by perpetuating an artificially low 10-year government bond rate, the Fed may be delaying the very fiscal policy action that the nation most needs, while doing little to boost an economy whose principal problem is not high long-term interest rates." The message, for anyone having read the prior two essays, or Zero Hedge, is nothing new. What is, is the massive onslaught by virtually everyone of any political and financial stature on this pretty much inevitable policy decision by Bernanke. The question we have is did Goldman's estimate that QE2 needs to be up to $4 trillion blow the party? Are expectations for future monetary easing so high (and unattainable) now that the market had to be artificially be pushed lower so there is some upside on November 3? Because for all those who believe that the Fed has found religion and thinks a strong dollar is suddenly a policy goal, we have two words: "Wake up."

Sailing the Wrong Way with QE2?, posted in the New York Times

To bolster the economy, we need a three-part shift in policy:

    · more fiscal expansion (read: more stimulus) now;

    · much more deficit reduction, enacted now, to take effect in two to three years; and

    · an improvement in the relationship between business and government (the current antagonism, even if not the primary explanation for slow hiring and sluggish investment, does seem to be affecting hiring and other business behavior).

Unfortunately, the necessary shifts in fiscal policy are extremely unlikely to happen, and the strains between business and government are now so deep that they will take time to address. So we’re left relying on monetary policy — and in particular a much-anticipated second round of quantitative easing by the Federal Reserve — which may create more problems than it solves.

As Paul Krugman and others have pointed out, the net effect of “QE2” is similar to having the Treasury sell short-term T-bills and using the proceeds to buy back 10-year bonds. The result is thus that the average maturity of government debt held outside the government falls. (From a debt management perspective and given current interest rates, the Federal government should probably be lengthening the average maturity of debt held by the public rather than reducing it, but let’s not worry about that for now.)

What are the benefits of such a reduction in the average maturity of government debt in the current economic environment?

They’re quite limited for two reasons. First, at the likely scale of the Fed’s purchases, the long bond rate will fall only modestly. And second, a modest reduction in long-term interest rates will not have much effect on economic activity at a time when corporations are flush with cash and worried about the future. (As Alan Blinder recently emphasized, “To attach some illustrative numbers to this concept, suppose the Fed succeeds in trimming government-bond rates by 30 basis points, and that brings down corporate bond rates by 15 basis points. Will that make a big difference to corporate spending?”) Many commentators, including a few presidents of the regional Federal Reserve banks, have noted the risks to the Fed’s credibility from QE2.

Ironically, QE2 could make the right policy mix less likely. In particular, any substantial additional stimulus will probably not (and should not) be enacted without a medium-term deficit reduction package — and that medium-term deficit reduction package is less likely to be enacted when interest rates on long-term government bonds are so low.

In other words, by perpetuating an artificially low 10-year government bond rate, the Fed may be delaying (even if very modestly, given the modest impact of the action on long rates) the very fiscal policy action that the nation most needs, while doing little to boost an economy whose principal problem is not high long-term interest rates.