U.S. QUANTITATIVE MEASURES WORKED IN DEFIANCE OF THEORY / THE FINANCIAL TIMES COMMENT & ANALYSIS

October 13, 2014 12:19 pm

US quantitative measures worked in defiance of theory

By Robin Harding in Washington

 

Ben Bernanke, former US Fed chairman: 'The problem with QE is it works in practice, but it doesn’t work in theory

 

Ben Bernanke was the US Federal Reserve chairman who used quantitative easing to fight the Great Recession of 2008-9, so it is fitting that he has the best line on how QE works.

 

Just before leaving the Fed this year, Mr Bernanke was asked if he was confident in advance that QE – the policy of buying bonds to drive down long-term interest rates when short-term rates are already at zero – would do the job. Mr Bernanke replied: “The problem with QE is it works in practice, but it doesn’t work in theory.”

With the Fed on course to end its asset purchases this month, after almost six years of off and on buying took its balance sheet from less than $1 trillion to $4.5 trillion, there is now plenty of evidence to test the theory. The Bank of Japan is still doing QE; the European Central Bank is pondering it. What happened in the US is of vital interest to them.

 

Mr Bernanke’s joke captures what many analysts think. There is some agreement that QE worked: in particular, the first round of purchases in 2009 helped to avoid a catastrophic depression. But there are deep questions about exactly how QE functioned and recognition of its limits. Much was achieved, but the US still suffered a painfully slow recovery.

Speaking on a recent panel about the Fed’s efforts to boost the economy despite zero interest rates, former vice-chair Donald Kohn said: “I think it’s fair to say that, although these [steps] were effective to some extent, people – even the Fed – were somewhat disappointed. It’s been a slow recovery from a very deep recession.”

There are dozens of academic studies on the effects of QE. Almost all find some impact on bond yields and, less clearly, on the economy: one Fed paper claims the central bank’s asset purchases reduced the unemployment rate in 2012 by 1.5 percentage points and averted a dip into deflation.

These studies are far from perfect, however. Most rely on the market reaction when each round of the programme was announced, which ignores what investors had already priced in, and says nothing about why QE moved asset values.

In theory, Fed’s purchases of Treasury bonds should have no effects. All that happens is the central bank swaps one kind of government debt – money – for another kind of government debt, in the form of a long-term Treasury bond. That can only make any difference if investors have a strong preference for one kind of debt over the other; Mr Bernanke’s argument is that, in practice, they do.

 

TO CONTINUE READING ARTICLE CLICK HERE