The Fed's $4 Trillion Bet
The U.S. Federal Reserve announced today that it will halt the bond-buying program known as quantitative easing -- one of the biggest experiments in economic policy ever attempted. The policy was a gamble, and it's too soon to be sure of the results. Nonetheless, the Fed was right to take the risk.
The Fed confirmed that it will cease the monthly bond purchases that it began in September 2012, the third round of its effort to invigorate a weak recovery. This doesn't mean the program is over. The Fed still holds more than $4 trillion in bonds, roughly a fifth of all U.S. Treasury and mortgage-backed securities outstanding. Until they're divested -- a challenge in its own right -- these vast holdings will continue to have an effect on markets.
Exactly how much QE has helped the economy remains a matter of debate. Former Fed Chairman Ben Bernanke said in 2012 that the Fed's first two rounds may have boosted output by 3 percent and added more than 2 million jobs. In a more recent paper, San Francisco Fed President John Williams said such estimates were uncertain; he also noted the risks to the financial system posed by so large an intervention. Some believe QE has gradually diminishing effects; others that it has no positive effect at all.
Regardless, the gamble was justified. After the crash a persistent slump in demand hobbled the recovery and drove up long-term unemployment, threatening great and lasting economic damage. With inflation low, the risks of QE were small in relation to the possible gains. The benefits weren't confined to the direct effects of the Fed's purchases: Even more important, QE bolstered confidence that the central bank was willing to do everything in its power to revive the economy.
If there's cause for regret, it isn't that the policy was undertaken, but that it ever had to be. In an ideal world, the crash would have been avoided in the first place; even in a less-than-ideal world, once it happened, expansionary fiscal policy should have shouldered more of the burden. After the initial fiscal stimulus, which was smaller than required, Congress moved too soon to fiscal stringency, and compounded that error by cutting the deficit in needlessly damaging ways. When it came to supporting demand, the Fed had to do it all -- and, with interest rates already at zero, that meant QE.
The second regret is that regulators haven't done more to protect the economy from the financial instability the Fed's policies might engender. The Fed's efforts to make banks finance themselves with more loss-absorbing equity are a step in the right direction. Yet the largest banks are still far too thinly capitalized, and regulators lack the data and mandates they need to identify and respond to risks building outside the banking system.
The sooner those weaknesses are dealt with, the better. The QE experiment won't be over until the Fed's balance sheet is brought back to normal, and in the meantime the extra risk of financial instability is there. Nonetheless, the verdict stands: Conditions demanded that the Fed be bold, and it was. It did the right thing.
--Editors: Mark Whitehouse, Clive Crook.
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