Last month, Ben Bernanke announced that if forecasts for the US economy met expectations next year, the currently indefinite cycle of QE (quantitive easing) would come to an end. The revelation comes nine months after the unprecedented commitments of QE3 and of QE4, effectively promises from Bernanke that the Fed will not let up on expansionary monetary policy until favourable market conditions are recovered. Whether such favourable conditions (specifically, improvements in the labour market) will be achieved within the next year is still under debate, but perhaps the most interesting question to ask now, with a foreseeable end in sight, is what exactly have the last four rounds of QE in the United States done to revive the economy, and has it responded as Bernanke and his contemporaries expected?
The simplest way to pick apart the QE timeline is to examine each round in turn. In most circumstances a round of easing is attributed its own time frame, however QE3 was the first instance of the practice structured to continue indefinitely until market improvements were observed.
Let’s begin by looking at QE1, initiated in November 2008, roughly 3 months after the Lehman Brothers collapse. The round lasted for 17 months, the longest so far, and by and large after its culmination it was considered a success. Each month, the Fed spent $100 billion to purchase mortgage backed securities ($1.7 trillion total) and within that year and half both gold and gas increased in value by over 50%, indicating that investment had enabled demand, at least at face value. The economy also appeared to have strengthened from supported credit markets and liquidity provided to the private sector, and in fact during its span, the first round of easing managed to lower interest rates by more than a full percentage point from 6.3% to 5.2%, which will have also worked toward stimulating growth. However, was QE1 a resounding success? Not everyone was in agreement. The primary qualification to this success, as most of us have heard many times, was that the banks that exchanged their toxic securities for cash had no incentive, and indeed no requirement, to lend it out, which more than dampened the intended effect.
However with this said, QE1 was deemed successful enough by the Fed to begin a second round of easing 7 months later, sometimes dubbed QE2. From November 2010 to June 2011, the round lasted 7 months, and the Fed purchased US treasuries by spending $85 billion in each. What should be noted is that the purchasing of different securities makes QE2 a very different animal to QE1. The fact that the Fed was buying up treasuries instead of the desperately defunct mortgage backed securities meant that whilst expanding its own balance sheet, the money meant for stimulating the economy was again mostly sitting in banks, and adding a buffer to their reserves.
As any casual examiner of current events will tell you, banks in both the US and UK haven’t exactly been bright-eyed and beaming when it comes to lending. As gold and gas each further increased in value by close to 28% during the round, the process was again hailed as something of a success by the Fed, and in general it was largely agreed that QE2 had been more successful than its predecessor. Asset prices are of course, only a base measure of an economy’s stability, but the market gains from the round were certainly significant, and interest rates that needed to be lowered to stimulate lending were in fact lowered, if only by 2/5ths of a percentage point to 4.6%.
Now, the dynamics get interesting. More than a year after QE2 was complete, the Fed went even further and announced QE3, with the controversial clause that a further purchasing of mortgage-backed securities would go on indefinitely, with no limit to purchases. So with the structure of QE3 fundamentally different, did it change the overall result of the policy? Like many questions in the realm of economics, there is no definite yes or no answer. Again, the Fed bought up both mortgage backed securities and treasuries, much as before, and the degree of spending per month remained static at $85 billion. One difference, however, was that QE3 was to work in tandem with Operation Twist, the Fed’s plan to sell the short term treasuries they had and use the funds to buy up longer term securities. The idea behind the exchange was to flood the market with the former, and thereby cause short term interest rates to rise; by buying up longer term securities they would also do the opposite, causing long term interest rates to fall. The “twist” in the naming of the operation came from the visible twist in the yield curve that was expected to result. Indeed, by all accounts Operation Twist was a novel idea (if not an original one, having been utilised in 1961) however novel ideas alone don’t fix broken economies. The real question was, did it work? Actually, despite its share of sceptics, it did. In June 2012, the yield on 10-year treasuries fell to 200-year lows, and as a result, the housing market bounced back somewhat, as did bank lending.
So, Operation Twist was a bold move by the Fed and a great success, but what about QE3 itself? For starters, the public response was certainly more varied. Though Bernanke was largely praised for attempting to instil a policy with viable promise of commitment, there was enormous pressure for QE3 from the political arena, where an arguably irresponsible level of fiscal spend essentially backed the Fed into a corner, further stifling an already limited toolkit. Indeed when QE3 was announced, the air of uncertainty was more than audible.
Many economists including David Rosenberg clamoured that the Fed was testing the economy too readily at its limits; gold was at a soaring high, and the dollar was lowest of the low, and Bernanke and his others, perhaps, were too content to watch the foundations wobble. However, over time QE3 did begin to produce results. The exceptionally low dollar, though riskier than most would be comfortable with, meant that US stocks became cheaper for international investors encouraging investment, and along the same vein, the attractive exchange rate meant that international trade received a boost, with exports eventually increasing during the period that QE3 was active. (Such delay could well be attributed to the J-Curve effect).
We know now that like its forebears, QE3 had its positives and its negatives, but many economists believed that the third iteration would be the last considering its unique properties. They were wrong, at least in a sense, as our defined rounds become somewhat skewed here. Some still speak as if QE3 is ongoing, while others insist that in considering the changes made by Bernanke, we are now in what has essentially evolved into QE4. In order to better make the distinction between what was initially QE3 and the subsequent changes to its structure from January of this year, we will from that period henceforth refer to the QE4.
At that time, the Fed announced a policy that targeted the unemployment rate directly, stating that QE4 would continue until either unemployment fell below 6.5%, or until core inflation rose above 2.5%. In its history, it was the first time that the Fed had ever done this. Again, Bernanke and others at the central bank were attempting to make a viable commitment, knowing that as much as what the actions themselves said, public expectations of the Fed’s actions were as important in order to revive confidence – and would in turn jumpstart the economy.
The next question to ask is, will QE4 maintain the overall successes, or mitigate the failures, of the previous rounds? One might assume that with the added commitment, the successes would at least remain constant, but there is one thing QE3 had that has ceased for QE4: Operation Twist.
Though the plan was perhaps more a success in itself than QE as a whole, the Fed cannot continue the plan, quite simply because it has sold off all the short term securities it might exchange for long term ones. A big part of what made QE3, QE3, therefore is missing. However with this point stated, there are several things QE4 will continue to do to build upon previous rounds: it will keep the dollar low to encourage investment from overseas, and it will keep mortgage and interest rates low, encouraging lending. Despite being the key target of the Fed, the job market still appears to be lagging behind, but the mantra seems to be “recovery first, jobs later,” even if officials are not openly admitting this. Whether growth in the labour market will be the case toward the end QE4, remains to be seen.
Overall, though QE as whole appears to be have been a moderate success, the policy has been dogged with a skeptical reception, and the primary complaint has been that yes, this is something of a start, but what about the average American? He or she needs a job now, not in 2015.
The truth here lies in the words of Bernanke himself several years ago that monetary policy is “not a panacea.” The sad fact is (and it seems many need reminding of this, time and time again) there is only so much the Federal Reserve can do to spark growth in a floundering economy. With the power of hindsight it appears that QE has done much of what it can, even if it wasn’t as powerful a tool as we all might have hoped.
One thing is certain: Bernanke and the Fed are under mounting pressure for further action; with Operation Twist at an end and much of the rest of the economic toolkit exhausted, is the next option as simple as QE5, or no? The answer to that, perhaps rests with the accuracy of Bernanke’s forecasts.