Five years into the era of quantitative easing pioneered by departing Federal Reserve Chairman Ben S. Bernanke, two economists say they’ve measured how much extra stimulus the bond purchases provide when the main interest rate is already near zero.
The economists, Jing Cynthia Wu and Fan Dora Xia, used a concept known as the “shadow rate” to gauge the impact of quantitative easing and the Fed’s forward guidance on the likely path of interest rates.
Their findings: as of December, Fed policy was the equivalent of cutting the benchmark interest rate to minus 1.98 percent, according to Wu at the University of Chicago Booth School of Business and Xia at the University of California at San Diego.
“The shadow rate is one device we can use to summarize Fed policies in a familiar way,” said James Hamilton, a professor at UCSD who worked with Wu and Xia as graduate students. “It’s a useful number that I would think the Fed would want to factor into its discussions and evaluations of how the market is reacting.”
Researchers at the Atlanta Fed have already taken notice. They plugged the estimate into their own economic models and found that “given the extra policy accommodation, we’d expect to see a bit more growth and a lower unemployment rate when using the shadow rate,” economists Pat Higgins and Brent Meyer wrote on the Atlanta Fed’s blog.
The simulation predicts growth of almost 3.5 percent at an annual pace in the first quarter of 2014, compared with about 3 percent without using the shadow rate and 2.5 percent forecast by economists in a Bloomberg survey. Growth will remain 0.1 or 0.2 percentage point stronger every quarter into 2015, according to the model’s predictions.
The economy expanded at a 3.2 percent pace in the fourth quarter, matching the median forecast in a Bloomberg survey of economists, a Commerce Department report showed yesterday.
Fed policy makers this week reduced the monthly pace of asset purchases for a second meeting, by $10 billion, to $65 billion. They also repeated that the federal funds rate is likely to stay near zero until “well past” the time that unemployment falls below 6.5 percent. The jobless rate was 6.7 percent in December, a five-year low.
Whether QE packs the same punch as interest-rate cuts remains one of the great unknowns of the policies introduced by Bernanke as he sought to restore the economy to health after the deepest recession since the Great Depression. Bernanke’s term ends today, and he will be succeeded by Vice Chairman Janet Yellen.
“A lot of people think if you can boil down what we’ve done to something that looks like the past policy tools, then you could do a more systematic analysis,” said Michael Hanson, a senior U.S. economist at Bank of America Corp. in New York and a former Fed economist.
Historically, the Fed has used its benchmark interest rate to steer the economy. The Fed lowered the rate to encourage borrowing and boost growth and employment, and raised it to cool off lending markets and slow inflation.
All that changed in December 2008, when the Fed reduced its target interest rate almost to zero.
“That number -- the fed funds rate -- is completely useless at the moment,” Hamilton said. “We need some other number to report what the Fed is doing and are they getting more contractionary or expansionary.”
Unable to cut its short-term rate below zero, the central bank embarked on three rounds of quantitative easing, totaling more than $3 trillion, to continue providing stimulus by pushing down long-term rates. That has made it cheaper for consumers and companies to borrow.
The untested nature of QE has left the Fed guessing at its precise power. Bernanke laid out a range of estimates in a speech in Jackson Hole, Wyoming, in August 2012, less than a month before the Fed started its third round of bond purchases.
Bernanke cited studies that found the Fed’s first two rounds of purchases lowered the yield on the 10-year Treasury note by 0.55 to 1.55 percentage points. The yield was at 2.7 percent late yesterday.
With only five years of data in the era of zero interest rates and QE, it’s too early for economists to measure the shadow rate with precision, said Drew Matus, senior economist at UBS Securities LLC in Stamford, Connecticut.
“There’s a lot of work and there’s a lot of uncertainty about QE’s effects,” said Matus, a former New York Fed analyst. “I don’t think we’ll really know the answer to what the Fed’s done for a number of years.”
If economists eventually agree on a shadow rate, that could help settle a debate on whether the Fed tightened policy when it announced $10 billion cuts in the monthly pace of bond purchases in December and again this week.
While the pace was reduced, the Fed’s balance sheet continues to expand, reaching a record $4.1 trillion this week. Fed officials say they are still easing policy because they are adding to their holdings of long-term securities.
“In theory, the Fed is the most accommodative whenever the balance sheet peaks,” said Joseph LaVorgna, chief U.S. economist at Deutsche Bank Securities Inc. in New York and a former New York Fed economist. “That’s when monetary policy is the easiest, not when they’re buying the fastest.”
Wu and Xia’s approach measuring the shadow rate supports that conclusion. In December, their measure declined to a record minus 1.98 percent, from minus 1.86 percent in November.
“The verdict is in with the Fed’s announcement of tapering,” said Hamilton, who added that the Fed also strengthened its commitment to hold interest rates near zero. “The net result of that announcement was an expansionary move.”
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