Bernanke said some things in his testimony to the Senate Finance Committee on Thursday that raise a question. One that I don’t have an answer to. All comments/thoughts/answers are welcome. I will send this off to the Fed. I doubt I will hear from them, but if I do, I will post the update.
Bernanke had this to say regarding the consequences of QE2:
Our analysis indicates that our actions (QE2) to be roughly equivalent to a 40-100 basis-point reduction in the Federal Funds rate.
Six months ago Bernanke said something similar to this. At that time he suggested that $200b of QE was equivalent to a 25 BP reduction in Federal Funds. The $600 QE2 was therefore a monetary policy equivalent to a 75 BP reduction in short-term interest rates. The range that Big Ben used this past week is evidence to me that the Fed is no longer so sure about the consequences of QE. However, the range that Ben used gives a mid-point back to that 75BP (25BP/$200b of QE).
Bernanke went on to applaud QE with this:
The net result of this action has lowered borrowing costs and created easier borrowing conditions throughout the economy.
What I get from this is that Bernanke believes (or he trying to convince us) that QE has a lasting and permanent consequence (until the QE action is reversed). I don’t believe that is correct. But I also don’t know how long the benefits of QE (if any) actually do extend. That’s my question to you (and the Fed). My effort at an answer:
There are only three possible results:
1) QE has a permanent consequence on monetary conditions (until reversed).
2) QE has only a very short-term consequence. The benefit of a POMO operation is transmitted within 24 hours. Once transmitted it has no lasting consequence.
3) Something in between 1 and 2.
For what it is worth I think the answer is 3. I disagree with Bernanke that it has a permanent consequence. I think that any benefits are short-lived; at most six-months. (My guess would be less than one month, but I hate QE)
I base my conclusion on the following:
The total of QE1 and 2 is $2.3 trillion. Using Bernanke’s rule of thumb that $200b of QE is equal to ¼% drop in Federal Funds (monetary equivalent) one would have to conclude that the cumulative affect would be -3% (2.3/0.2). I see no evidence that current monetary stimulus is equal to minus 3%. If it were, the economy would not be struggling as it is and inflation would be much higher than is being recorded.
Bernanke has painted himself into a corner with this. He is maintaining that the answer is #1. That is the least likely possibility IMHO. To my knowledge, the Fed has not factually demonstrated this conclusion. I think it is important that they do so.
I would warn those Fed economists that if they try to defend the notion that there is a perpetual benefit to QE you are on very thin ice. There is no data to support that conclusion. If you try to convince us that the value of QE extends for more than one year, your message will not be credible. If you conclude that the benefit of QE is less than six months, you have a problem.
If the answer to this question is that any consequence of QE is short lived, then the Fed must take this policy option off of the table and put it back on the shelf. It might be a useful tool in an extreme emergency (2008) (where an immediate and significant short-term monetary shock is required to stabilise a sinking ship). But QE has no role to play in normal monetary operations.
Face it Mr. Bernanke (and cohorts), monetary policy is range bound at zero. QE can’t push through this barrier. Your quiver is empty.
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