Yellen Sees QE as a Tool of the Future But Her Successor May NotBy and
Program benefits debated ahead of expected drawdown decision
Fed shrinking balance sheet seen as return to policy-as-normal
A decade after the financial crisis first flickered, the U.S. is set this week to lead the developed world in exiting unconventional policies that central banks unleashed to save the global economy. And while it will take years to complete, dismantling the politically controversial quantitative easing program is being welcomed by supporters and critics alike as an important marker on the road to normalcy after the ravages of the Great Recession.
Left unanswered is what comes afterward. Will the once unconventional become more conventional and end up being a trusted part of the Federal Reserve’s tool kit when the next recession hits, as the current crop of central bankers led by Chair Janet Yellen seems to believe? Or will QE be relegated to a rarely used instrument that is only turned to in the deepest of crises, as some of President Donald Trump’s presumed monetary policy makers in waiting appear to advocate?
“We could be talking about a new world here,” said Decision Economics Inc. president Allen Sinai.
Fed Vice Chairman Stanley Fischer has already announced he’s resigning and that the Federal Open Market Committee’s two-day meeting starting Tuesday will be his last. Yellen’s time atop the central banks runs out in February, unless Trump decides to re-nominate her.
The fate of the strategy has huge implications for investors. While the economic effects of QE are hard to quantify, the policy has had an outsized impact on financial markets. By buying up bucket loads of bonds and quintupling its balance sheet to $4.5 trillion, the U.S. central bank pushed long-term yields down and equity values up. That’s led to criticism that it distorted markets and unduly favored wealthy shareholders.
After months of preparation and telegraphing their plan to markets, the policy-making FOMC is expected to announce the start of a balance sheet draw-down on Wednesday. It intends to begin slowly, with monthly reductions of just $10 billion. The cutbacks will come even as the European Central Bank and the Bank of Japan continue to add to their holdings.
QE, as practiced in the U.S., was three separate programs. The first, initiated in late 2008 at the height of the crisis, was heavily weighted toward the purchase of mortgage-backed securities.
Launched the day after Republicans scored big wins in the 2010 congressional elections, QE2 was condemned by a host of lawmakers, including then Indiana representative and now Vice President Mike Pence, who worried about an outbreak of inflation that never materialized.
The Fed began QE3 two years later, eventually promising to continue to buy MBS and Treasuries until the labor market outlook improved substantially.
“I would give an A to QE1 and a B- to all the rest,” said former Fed Vice Chairman and now Princeton University professor Alan Blinder. “QE1 was very well timed, very well targeted“ and helped restore order to chaotic financial markets, he said. “But the rest probably had modest effects.”
While broadly agreeing about the necessity of QE1, former Philadelphia Fed President Charles Plosser argues that subsequent programs led to a lot of financial engineering by companies using borrowed money to buy shares and pay out dividends, and not much capital investment.
“It’s pretty clear that QE works in terms of having the expected impact on bond-market yields, and on asset prices more generally,” Harvard University professor and former Fed Governor Jeremy Stein said in an email. While it’s a “bit of a leap to conclude that it also stimulates” the economy, he voiced confidence “there was some meaningful real effect.”
Yellen and her colleagues have already declared that they might restart asset purchases if the economic situation was dire enough. Behind that assertion: Concern that the Fed might not have enough firepower to revive a weakened economy through conventional monetary policy because short-term interest rates won’t be that far from zero.
Asset purchases are now an “important” component of the Fed’s monetary policy toolkit, Yellen told the central bank’s annual symposium in Jackson Hole, Wyoming, in 2016.
Such talk leaves some conservative economists uneasy.
QE “is ‘unconventional’ monetary policy and should not be needed under normal business cycle conditions in the future,” Harvard University professor Martin Feldstein said in an email.
He took issue with arguments that the central bank will hit the zero lower bound more frequently in the years ahead. “Once the Fed stops supporting super low interest rates the risk of being at the lower bound will no longer be important,” he said.
Some of Trump’s potential picks to the Fed board also have qualms about QE.
“The effectiveness of more balance-sheet stimulus is questionable,” Carnegie Mellon University professor Marvin Goodfriend said in a 2016 presentation at Jackson Hole.
Goodfriend, who is widely reported to be under White House consideration for a Fed governor post, has backed pushing interest rates below zero if needed to aid the economy.
Hoover Institution fellow Kevin Warsh, who’s among those said to be in the running to succeed Yellen, opposed the launch of QE2 when he was a Fed governor, though he voted for it out of deference to then Chairman Ben Bernanke, according to the transcript of the FOMC’s meeting in November 2010.
Another potential Fed chairman, Stanford University professor John Taylor, has also sharply criticized QE. If the Fed hit the zero lower bound and needed to aid the economy, Taylor would prefer it first used forward guidance -- a communications strategy that commits the Fed to keeping short-term rates lower for longer -- tied to a monetary policy rule to help bring long-term interest rates down.
Chicago Fed President Charles Evans has voiced concern that some of the “hard-learned expertise” the Fed gained in employing QE during the crisis will be lost with a “changing of the guard” at the central bank.
“There is nothing easy about quantitative easing. The resulting large balance sheets are controversial,” he said in a March 29 speech in Frankfurt, adding, “Future committees may have to relearn how to take necessary but unpopular actions.”
— With assistance by Christopher Condon, and Christopher Cannon