We have lived through quite an extraordinary period since Quantitative Easing began to spread on a large scale in 2008. Japan had already been trying QE for some time and if I remember correctly was up to QE 13 which did not seem to trouble anyone as much as it should have, as after all if something needs that many attempts you should question if it works at ll? Also according to the central bankers QE was supposed to raise inflation as they got out their economic textbooks and hoped they were correct. Of course as Japan was already into the Lost Decade era it was plain that the QE era had not done that for it.
If we look back we see that there are three potential routes to an economic impact. The first is that there is an expansion of the money supply as in return for the bonds the central bank provides electronic money. The second is that all the bond buying drove bond yields lower. The third is that the currency is supposed to fall in response to the higher supply of money thus creating inflation via more expensive imports. These we supposed to raise inflation to the economic sweet spot of 2% per annum which for reasons which have never been explained is supposed to be an economic sweet spot leading to economic growth and everything singing along with the Beatles.
I’ve got to admit it’s getting better (better)A little better all the time (it can’t get no worse)I have to admit it’s getting better (better)It’s getting better
The trouble is that results were patchy at best and sometimes none existent, so let us look in more detail.
Money Supply
In aggregate there were enormous changes here.
Before the Great Recession, the Fed’s assets were mostly Treasuries, and its liabilities consisted largely of currency in circulation. The size of its balance sheet was also much smaller than it is today, hovering around $800 billion. ( Richmond Fed)
The present number is more like US $8.6 trillion as the Federal Reserve got up to nearly 9 trillion. In fact its two main waves wee roughly the same size as the credit crunch response and covid response were similar with the second being faster.
But to my mind much of the impetus got stuck in the monetary system or as the Richmond Fed puts it.
On the liabilities side, the Fed paid for these purchases mostly through the creation of reserves, which are cash balances that banks hold at the Fed and on which the Fed pays interest.
We can take that further by looking at this from a piece in the Financial Times.
At the end of 2022, the US banking system had $18tn in domestic deposits, including an estimated $10tn of deposits insured by the Federal Deposit Insurance Corporation. That meant there were $8tn of deposits that exceeded the FDIC insurance limit. Those destabilising excess deposits are there because in more than a decade of “quantitative easing”, the Federal Reserve took $8tn of bonds out of the hands of the public and replaced them with bank reserves.
Care is needed with this sort of thing as in my experience things that have to be true in mathematical terms have a habit of breaking down. But there is a point as the money supply boost often hot stuck in the system. I recall in my own country the UK the Bank of England got back some £260 billion of the £375 billion of QE it has undertaken at that point.
So rather than being “high-powered money” as the economic textbooks would have described it and maybe some still do. The reality was that in the first wave of QE a lot of it got stuck in the system.
Bond Yields
There are several ironies in this section. The first is what seemed low bond yields in the first QE wave suddenly seemed rather high in the second! I recall a 2% yield seeming extraordinarily low for the UK ten-year and then when we saw 0.5% post Covid rather high! But all that buying did give us lower bond yields although in some waves it was not as clear cut as you might think. For example the ECB moves were often well forecast meaning that bond yields moved in advance of the actual buying.
Then with the surge in QE in both volume and speed terms we saw highs for bond prices and lows for bond yields. Indeed if we take the case of the Euro area we saw even Italy have its shorter-term bonds with negative yields as the world built up to around US $14 trillion of negative yielding bonds. Even my country the UK had some bonds maturing around now ( so they were of around 3 year maturity at the time) briefly having negative yields as the central bankers got high on their own power.
What these lower bond yields have us was much higher asset prices. The simplest was in bond prices and this led to all sorts of consequences. Next up was equity markets although the precise impact is hard to quantify. Then there was house prices and this built over time as buyers adjusted and for example in my country the UK switched to fixed-rate mortgages which got cheaper and cheaper. This was exacerbated post Covid as I think we even saw some deals get down to 1% and many below 2% which fed the house price surges we saw.
So the consequence here was that the world was changed in favour of those who owned assets which is essentially the wealthiest.
Also it blew up the concept of the “safe asset” as the US Treasury Bond was anything but safe as the recent blow-up of SVB proved.
Exchange Rates
In the economics text books the situation was simple. If you supply more of your currency then the price falls. Sadly for the authors what they thought was a Q.E.D. turned out to be riddled with problems. The most basic one was that they had considered the event in isolation when in fact pretty much everyone was at the same game. In the rush of interest-rate cuts and QE there were moves but were more relative than absolute.
Then there were other factors such as the Carry Trade blowing up pushing the Japanese Yen and Swiss France and to some extent the Euro higher. Even if we look at the price of gold against in a sense the fiat currencies the picture failed. Yes it rose as QE began but lower interest-rates were also in play. Then it disappointed Gold Bugs when we saw the post Covid moves. In total we can see that Bitcoin and the other coins emerged and grew due to the era we were in but they have been so volatile in price terms one can only discuss them as a broad sweep.
Comment
As you can see the original reasons for QE mostly crumbled. Whilst there were some rises in inflation and perhaps economic growth the simple fact was that the narrow money push did not go into the broader economy as intended. Well assuming that you are not one of those who think it was only ever around higher asset prices! Chopping bond yields has led to all sorts of consequences which were not intended as this from the Richmond Fed highlights.
Under the Odyssean version, QE reinforces the Fed’s verbal commitment to keep short-term rates lower for longer by tying monetary policymakers to the mast, so to speak. Because the interest the Fed earns on the long-term securities it acquires through QE is largely fixed while the interest it pays on reserves changes with monetary policy, the Fed opens itself up to losses if it were to start raising interest on reserves before reducing the size of its balance sheet.
Actually central banks now have large losses which they have inflicted on themselves by raising interest-rates. There are other agents such as pension funds and insurance companies which not only bought such bonds were pressed to buy more by the rules at the time. We saw a consequence of some of that last autumn in the UK. There was an utter failure here and the authorities rather than stopping it encouraged it.
Next up is why was the Covid era so different? After all this time we were plunged into an inflation crisis. Much of this was the other side of the policy response because first time around we saw attempts at fiscal austerity whereas this time we saw fiscal stimulus on a grand scale. As I pointed out at the time we saw an implicit debt monetisation for which we are paying the price.
This brings me to what QE gave us. The big change was that the wealthier were made much better off by the higher asset prices. Whereas the ordinary person now finds themselves being told this.
Wunsch: ECB To Keep Raising Rates Unless Wage Growth Slows ( FT)
At a time when real wages have been falling. We have seen central banks involve themselves in quite a redistribution of wealth and income.