Quantitative Easing Rounds 1 and 2 Hurt the Economy ... Bernanke Proposes Round 3

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Washington’s Blog

Federal Reserve chairman Ben Bernanke is hinting at a third round of quantitative easing.

But Dallas Federal Reserve Bank president Richard Fisher said today:

I firmly believe that the Federal Reserve has already pressed the limits of monetary policy. So-called QE2, to my way of thinking, was of doubtful efficacy, which is why I did not support it to begin with. But
even if you believe the costs of QE2 were worth its purported
benefits, you would be hard pressed to now say that still more
liquidity, or more fuel, is called for given the more than $1.5
trillion in excess bank reserves and the substantial liquid holdings
above the normal working capital needs of corporate businesses.

Indeed, Bernanke knew in 1988 that quantitative easing doesn't work:

Ed Yardley notes:

economists, Seth B. Carpenter and Selva Demiralp, recently posted a
discussion paper on the Federal Reserve Board's website, titled
"Money, Reserves, and the Transmission of Monetary Policy: Does the
Money Multiplier Exist?" [Here's the link.]


study states:] "In the absence of a multiplier, open market
operations, which simply change reserve balances, do not directly
affect lending behavior at the aggregate level. Put differently, if
the quantity of reserves is relevant for the transmission of monetary
policy, a different mechanism must be found. The argument against the
textbook money multiplier is not new. For example, Bernanke and
Blinder (1988) and Kashyap and Stein (1995) note that the bank lending
channel is not operative if banks have access to external sources of
funding. The appendix illustrates these relationships with a simple
model. This paper provides institutional and empirical evidence that
the money multiplier and the associated narrow bank lending channel
are not relevant for analyzing the United States."


Did you catch that? Bernanke knew back in 1988 that quantitative easing doesn't work.
Yet, in recent years, he has been one of the biggest proponents of the
notion that if all else fails to revive economic growth and avert
deflation, QE will work.


(Indeed, a large percentage of the bailout money went to foreign banks (and see this). And so did most of money from the second round of quantitative easing.)

I pointed out in January:

The stated purpose of quantitative easing was to drive down interest rates on U.S. treasury bonds.

But as U.S. News and World Reported noted last month:

now, you've probably heard that the Fed is purchasing $600 billion in
treasuries in hopes that it will push interest rates even lower, spur
lending, and help jump-start the economy. Two years ago, the Fed set
the federal funds rate (the interest rate at which banks lend to each
other) to virtually zero, and this second round of quantitative
easing--commonly referred to as QE2--is one of the few tools it has left
to help boost economic growth. In spite of all this, a funny thing
has happened. Treasury yields have actually risen since the Fed's

The following charts from Doug Short update this trend:




Click to View


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course, rather than admit that the Fed is failing at driving down
rates, rising rates are now being heralded as a sign of success. As the
New York Times reported Monday:


trouble is [rates] they have risen since it was formally announced in
November, leaving many in the markets puzzled about the value of the
Fed’s bond-buying program.




But the biggest
reason for the rise in interest rates was probably that the economy
was, at last, growing faster. And that’s good news.

“Rates have risen for the reasons we were hoping for: investors are more
optimistic about the recovery,” said Mr. Sack. “It is a good sign.”


November, after it started to become apparent that rates were moving
in the wrong direction, Bernanke pulled a bait-and-switch, defending
quantitative easing on other grounds:

This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose
and long-term interest rates fell when investors began to anticipate
the most recent action. Easier financial conditions will promote
economic growth. For example, lower mortgage rates will make housing
more affordable and allow more homeowners to refinance. Lower corporate
bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending.
Increased spending will lead to higher incomes and profits that, in a
virtuous circle, will further support economic expansion.

As former chief Merrill Lynch economist David Rosenberg writes today:

the Fed Chairman seems non-plussed that Treasury yields have shot up
and that the mortgage rates and car loan rates have done likewise,
even though he said this back in early November in his op-ed piece in
the Washington Post, regarding the need for lower long-term yields:


example, lower mortgage rates will make housing more affordable and
allow more homeowners to refinance. Lower corporate bond rates will
encourage investment.”


But the Fed Chairman is at least getting
what he wants in the equity market. Recall what he said back then —
“higher stock prices will boost consumer wealth and help increase
confidence, which can also spur spending. Increased spending will lead
to higher incomes and profits that, in a virtuous circle, will further
support economic expansion.”


So now the Fed has added a third mandate to its charter:


1. Full employment
2. Low and stable inflation
3. Higher equity valuation


real question we should be asking is why Ben didn’t add this third
policy objective back in 2007 and save us from a whole lot of pain over
the next 18 months?


And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending.

Indeed, leading economic consulting firm Trim Tabs (25% of the top 50 hedge funds in the world use TrimTabs' research for market timing) wrote on Wednesday:

Federal Reserve’s quantitative easing programs have helped stock
market participants, financial institutions, and large companies but
have done little to address the structural problems of the economy,
according to TrimTabs Investment Research.

“Quantitative easing
is supposed to produce stronger economic growth and lower
unemployment,” said Madeline Schnapp, Director of Macroeconomic
Research at TrimTabs. “While QE1 and QE2 have worked wonders on the
stock market, their impact on GDP and jobs has been anemic at best.”

Similarly, Ambrose Evans-Pritchard wrote today:

Fed no longer even denies that the purpose of its latest blast of
bond purchases, or QE2, is to drive up Wall Street, perhaps because
it has so signally failed to achieve its other purpose of driving
down borrowing costs.



bottom line is that quantitative easing is not really helping the
average American very much ... and is certainly not worth trillions of

I've also noted that quantitative easing creams the little guy:

Graham Summers points out that food prices have also skyrocketed [during both rounds of quantitative easing]:

case you’ve missed it, food riots are spreading throughout the
developing world Already Tunisia, Algeria, Oman, and even Laos are
experiencing riots and protests due to soaring food prices.


As Abdolreza Abbassian, chief economist at the UN’s Food and Agriculture Organization (FAO), put it, “We are entering a danger territory.”


Indeed, these situations left people literally starving… AND dead from the riots.


And why is this happening?


perfect storm of increased demand, bad harvests from key exporters
(Argentina, Russia, Australia and Canada, but most of all, the Fed’s
money pumping. If you don’t believe me, have a look at the below chart:



[Summers shows the share price of Elements Rogers International Commodity Agriculture ETN as a proxy for food prices generally.]


you can see, it wasn’t until the Fed announced its QE lite program
that agricultural commodities exploded above long-term resistance. And
in case there was any doubt, QE 2 sent them absolutely stratospheric.

This isn't really unexpected.

Last November, David Einhorn warned:

is quite likely that QE2 will slow the economy by raising food and
energy prices [because it is easier to generate these price increases].
[These price hikes] would act as a tax on consumers and businesses.

Also in November, Karl Denninger wrote:

have a Federal Reserve that, in the last two years, has printed and
debased the currency of this nation by more than 100%, taking their
balance sheet from $800 billion to more than $2 trillion. They now
threaten, today, to do even more of that. This has resulted in insane
price ramps in soft commodities ....

("soft commodities" means food crops).

As the Wall Street Journal, Tyler Durden, the Economic Policy Journal and others note, inflation in food prices isn't limited to developing nations, but is coming to the U.S.

But - as I've repeatedly pointed out - it helps the big boys:

As I noted when the government started bailing out the big banks:


[The] Treasury Department encouraged banks to use the bailout money to buy their competitors, and pushed through an amendment to the tax laws which rewards mergers in the banking industry.

Yesterday, former Secretary of Labor Robert Reich pointed out that quantitative easing won't help the economy, but will simply fuel a new round of mergers and acquisitions:

debate is being played out in the Fed about whether it should return
to so-called "quantitative easing" -- buying more mortgage-backed
securities, Treasury bills, and other bonds -- in order to lower the
cost of capital still further.



The sad reality is that cheaper
money won't work. Individuals aren't borrowing because they're still
under a huge debt load. And as their homes drop in value and their jobs
and wages continue to disappear, they're not in a position to borrow.
Small businesses aren't borrowing because they have no reason to
expand. Retail business is down, construction is down, even
manufacturing suppliers are losing ground.


That leaves large
corporations. They'll be happy to borrow more at even lower rates than
now -- even though they're already sitting on mountains of money.


this big-business borrowing won't create new jobs. To the contrary,
large corporations have been investing their cash to pare back their
payrolls. They've been buying new factories and facilities abroad
(China, Brazil, India), and new labor-replacing software at home.


Bernanke and company make it even cheaper to borrow, they'll be
unleashing a third corporate strategy for creating more profits but
fewer jobs -- mergers and acquisitions.

Similarly, Yves Smith reports that quantitative easing didn't really help the Japanese economy, only big Japanese companies:

A few days ago, we noted:

When an economy is very slack, cheaper money is not going to induce much in the way of real economy activity.


you are a financial firm, the level of interest rates is a secondary
or tertiary consideration in your decision to borrow. You will be
interested in borrowing only if you first, perceive a business need
(usually an opportunity). The next question is whether it can be
addressed profitably, and the cost of funds is almost always not a
significant % of total project costs (although availability of funding
can be a big constraint)…..


So cheaper money will operate
primarily via their impact on asset values. That of course helps
financial firms, and perhaps the Fed hopes the wealth effect will
induce more spending. But that’s been the movie of the last 20+ years,
and Japan pre its crisis, of having the officialdom rely on asset
price inflation to induce more consumer spending, and we know how both

Tyler Cowen points to a Bank of Japan paper by Hiroshi Ugai, which looks at Japan’s experience with quantitative easing from 2001 to 2006. Key findings:

macroeconomic analyses verify that because of the QEP, the premiums
on market funds raised by financial institutions carrying substantial
non-performing loans (NPLs) shrank to the extent that they no longer
reflected credit rating differentials. This observation implies that
the QEP was effective in maintaining financial system stability and an
accommodative monetary environment by removing financial institutions’
funding uncertainties, and by averting further deterioration of
economic and price developments resulting from corporations’
uncertainty about future funding.


Granted the positive above
effects of preventing further deterioration of the economy reviewed
above, many of the macroeconomic analyses conclude that the QEP’s
effects in raising aggregate demand and prices were limited. In
particular, when verified empirically taking into account the fact that
the monetary policy regime changed under the zero bound constraint of
interest rates, the effects from increasing the monetary base were
not detected or smaller, if anything, than during periods when there
was no zero bound constraint.

Yves here, This is an important conclusion, and is consistent with the warnings the Japanese gave to the US during the financial crisis,
which were uncharacteristically blunt. Conventional wisdom here is
that Japan’s fiscal and monetary stimulus during the bust was too slow
in coming and not sufficiently large. The Japanese instead believe,
strongly, that their policy mistake was not cleaning up the banks. As
we’ve noted, that’s also consistent with an IMF study of 124 banking crises:

empirical research has shown that providing assistance to banks and
their borrowers can be counterproductive, resulting in increased losses
to banks, which often abuse forbearance to take unproductive risks at
government expense. The typical result of forbearance is a deeper
hole in the net worth of banks, crippling tax burdens to finance bank
bailouts, and even more severe credit supply contraction and economic
decline than would have occurred in the absence of forbearance.


analysis to date also shows that accommodative policy measures (such
as substantial liquidity support, explicit government guarantee on
financial institutions’ liabilities and forbearance from prudential
regulations) tend to be fiscally costly and that these particular
policies do not necessarily accelerate the speed of economic recovery.
Of course, the caveat to these findings is that a counterfactual to
the crisis resolution cannot be observed and therefore it is difficult
to speculate how a crisis would unfold in absence of such policies.
Better institutions are, however, uniformly positively associated with
faster recovery.

But (to put it charitably) the
Fed sees the world through a bank-centric lens, so surely what is good
for its charges must be good for the rest of us, right? So if the
economy continues to weaken, the odds that the Fed will resort to it
as a remedy will rise, despite the evidence that it at best treats
symptoms rather than the underlying pathology.

And as I noted last year, no Keynesian economics can work when the economy has major structural defects which have not been addressed:
implemented his New Deal stimulus at the same time that Glass-Steagall
and many other measures were implemented to plug the holes in a
corrupt financial system. The gaming of the financial system was
decreased somewhat, the amount of funny business which the
powers-that-be could engage in was reined in to some extent.

such, the economy had a chance to recover (even with the massive
stimulus of World War II, unless some basic level of trust had been
restored in the economy, the economy would not have recovered).

Today, however, Bernanke ... and the rest of the boys haven't fixed any of the major structural defects in the economy.
So even if Keynesianism were the answer, it cannot work without the
implementation of structural reforms to the financial system.

little extra water in the plumbing can't fix pipes that have been
corroded and are thoroughly rotten. The government hasn't even tried to
replace the leaking sections of pipe in our economy.

Quantitative easing can't patch a financial system with giant holes in it.