Sizing Up QE Now That It's Ended
When I was taking an advanced macroeconomics course at the University of Michigan in 2007, Miles Kimball, my professor -- and later my doctoral adviser -- explained to the class how to fight a recession. “Print money and buy stuff,” he exclaimed. Then, for good measure, he repeated the phrase three more times.
“Stuff,” in this case, meant financial assets. Kimball subscribed (and still subscribes) to the idea that macroeconomic management is all about money. When times are tough, investment is low and unemployment is high, the government -- i.e., the central bank -- should create money and exchange it for financial assets. If buying government bonds doesn’t do the trick, the bank can buy all sorts of other things -- housing-backed bonds, stocks, even houses themselves -- until the economy sputters back to life.
This idea is sometimes called monetarism, though it’s also associated with a school of thought called New Keynesianism. The idea that exchanging money for financial assets can overcome a downturn was enthusiastically promoted by Milton Friedman, the great prophet of monetarism. When Japan was in a prolonged slump in the 1990s, Friedman advocated just such a large-scale asset-purchase program:
The [Japanese] economy went into a recession. … Monetary growth has been too low. Now, the Bank of Japan’s argument is, “Oh well, we’ve got the interest rate down to zero; what more can we do?”
It’s very simple. They can buy long-term government securities, and they can keep buying them and providing high-powered money until the high powered money starts getting the economy in an expansion.
Thus was born the idea of quantitative easing, or QE for short. Japan used the policy in the 2000s, and much of the developed world adopted it during the Great Recession in 2009 and beyond. It was the great triumph of monetarist influence, though Friedman didn’t live to see it.
Now the Federal Reserve is officially ending that policy (though some would say it unofficially ended a year ago). Federal Reserve Chair Janet Yellen has said that the bank will begin divesting itself of the huge pile of financial assets that it bought during the last decade. Though QE continues in Japan and Europe, the great monetarist experiment is over -- at least for now -- in the home of the economists who conceived of it.
What have we learned from that experiment? The answer will be important for future policy makers. Put simply, did QE work?
Like all macroeconomic questions, this is a hard one to answer. We don’t really know how fast the economy would have grown in the absence of QE. Some people, such as former Fed Chairman Ben Bernanke, think the effect was large. And it’s true that the Great Recession in the U.S. didn’t end up being anywhere nearly as severe as the Great Depression of the 1930s. But that could be due to other reasons -- many fewer bank failures, more government stimulus spending or simply a more robust modern economy. It’s also true that the U.S. recovered faster from the shock than Europe did -- but again, that might be due to differences in fiscal policy, or to different initial conditions.
Some might be tempted to conclude that QE had no effect on the economy. Successive rounds of asset purchases from late 2008 through 2013 expanded the Fed’s balance sheet enormously, but U.S. employment didn’t really start recovering in earnest until 2014, after asset purchases were already being tapered off.
But it’s possible that without QE, the recovery would have taken even longer, or been less robust when it happened. Friedman was fond of saying that monetary policy has “long and variable lags,” meaning that you never quite know when the effect will kick in.
To assess the impact of QE on the economy, you need a model. The problem is macroeconomic models are famously unreliable -- all of them contain highly stylized assumptions, and all of them have trouble fitting the data in a number of ways. In fact, many models say QE should have no effect whatsoever. There is a cornucopia of models claiming QE helps, but for a variety of totally different reasons.
In other words, we don’t know how much QE boosted the real economy, and we probably never will. But we have learned one very important thing about the policy -- it doesn’t lead to high inflation.
Back when QE was beginning, there were widespread expectations of hyperinflation. That makes sense if you think of money as something created by the government -- since inflation is a drop in the value of money, it makes sense that printing more money would reduce its value. But despite all the loud warnings, inflation never materialized.
Japan, despite an even more dramatic asset-purchasing program in which the central bank bought up much of that country’s stock market, hasn’t managed to hit its meager inflation target of 2 percent in a sustained fashion.
Meanwhile, other anticipated dangers of QE, like asset bubbles and financial instability, also have quite conspicuously failed to materialize.
So although we’ll never know how much QE helps the real economy, we do know that it’s not the risk that many once believed. Monetarism may or may not help, but it probably doesn’t hurt. That’s an important lesson for future policy makers. Although QE’s day may be drawing to a close, it looks like it’s a valuable device that should remain in the central bank tool kit.
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