Thursday, April 28, 2011
Quantitative Easing: The most important ineffective strategy ever!
Quantitative Easing has become the new “hot term” for a policy that in reality does pretty much next to nothing.
Quantitative easing is the term used when the central bank has already lowered its target rate (Fed funds) to zero and can go no lower. So to act like it’s still doing something, it buys securities somewhere else along the term structure and continues adding to bank reserves. In QE2 the Fed targeted government bond yields and bought Treasuries. In QE1 the Fed targeted mortgage rates and bought mortgage backed securities.
When the Fed buys Treasuries it’s as if the Government never sold them in the first place. It is removing that supply of Treasuries that was first put there by government debt sales. And remember, Treasuries comprise part of the financial assets held by the public, so you’re basically taking those assets away.
Here’s what happens…
The public gets stripped of one asset—a Treasury—and loses the 3.5% interest payment (I’m using the 10-year) and gets another asset—a reserve balance—with a 0.25% interest payment.
The public has just lost 325 basis points of interest income!!! Some deal!!!!
Yet people view this as being wildly inflationary and stimulative. You can clearly see, it’s not. In fact, one could argue that the loss of interest income is really deflationary, particularly when so many people remain unemployed.
So why does the market rally on this and commodities go crazy?
Good question. I really don’t know. Probably a belief that QE does a lot more than it does.
But if that’s what it takes to move the market, it’s good enough. The Fed may know this and is manipulating expectations. The Fed is big on “expectations theory.”