Understanding Why You Think QE Didn't Work

The right question isn't always what happened, but what might have happened in the absence of action.
This woman has a problem: There are no answers for the most important questions. Photographer: Andrew Harrer/Bloomberg.

Maybe you have heard a line that goes something like this: The weak recovery is proof that the Federal Reserve's program of asset purchases, otherwise known as quantitative easement, doesn't work.

If you were the one saying those words, you don't understand the counterfactual.

That is the only conclusion I can draw from this common criticism of the Fed's policies of zero interest rates and QE.

This flawed analytical paradigm has many manifestations, and not just in the investing world. They all rely on the same equation: If you do X, and there is no measurable change, X is therefore ineffective.

The problem with this "non-result result" is what would have occurred otherwise. Might "no change" be an improvement from what otherwise would have happened? No change, last time I checked, is better than a free-fall.

If you are testing a new medication to reduce tumors, you want to see what happened to the group that didn't get the test therapy. Maybe this control group experienced rapid tumor growth. Hence, a result where there is no increase in tumor mass in the group receiving the therapy would be considered a very positive outcome.

QuickTake The Fed's Taper

We run into the same issue with QE. In the absence of a functional Congress or an adequate post-recession stimulus program, the Fed is the only game in town. Neither you nor I truly know what the impact of QE has been. Without that control group, we simply don't know. I have my suspicions, you have yours. But neither of us truly knows.

What is a counterfactual? I like to think about it as a hypothetical universe, identical to our own, with a single exception. That change could be a different policy, event or action. If that universe is identical to our own in all other respects, how do subsequent events there deviate from those here?

The 1979 bailout of Chrysler is my favorite example of a counterfactual. Consider what might have occurred if, instead of rescuing the beleaguered automaker, we allowed nature to take its course. As I discussed in "Bailout Nation," I can imagine an intriguing alternative history for Chrysler, and indeed, the entire Detroit auto-making industry.

Had Chrysler been allow to collapse, its assets probably would have been grabbed by someone. Private equity might have tried to remake the company without its onerous contracts. Perhaps a Honda or Toyota would have bought the assets for pennies on the dollar.

But the intriguing question is what happens to the rest of Detroit. A Chrysler failure might have forced deep introspection at Ford and General Motors. Perhaps their attitudes toward fuel efficiency and manufacturing quality would have changed. Or wage and benefit costs. We can only imagine how that alternative world would have looked.

The rescue plan was widely acclaimed as a success. The numbers, however, tell a different story. At the time of the bailout, Detroit sold 80 percent of all new vehicles in this country; that's down to about 45 percent. There were 2 million unionized auto workers then; since then, union membership has fallen almost 90 percent.

So much for that success story.

The counterfactual seems to get loss in most discussions of QE. Those engaged in the debate -- either ignorantly or disingenuously -- make claims such as "Look how few jobs have been created, and look how high unemployment is."

But because there is no control group, the right question to ask is "How many fewer jobs would have been created? How much higher would unemployment be?"

The honest and accurate answer: We just don't know….

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