A widespread refrain is that Ben Bernanke’s QE is failing because rates are surging, and higher ates are bad for the economy.
John Mauldin is just one of many to make that argument in his latest weekly piece.
But lower rates aren’t the goal, actually. As Minneapolis Fed President Narayan Kacherlakota recently argued, the goal is to lower real interest rates (Note: A big thanks to @obsoletedogma for the links and the chart):
The main goal of QE is to lower the long-run real interest rate. Here, by real interest rate, I’m referring to the interest rate net of expected inflation. More specifically, suppose that the interest rate on a 10-year bond is about 2.5 per cent and that people expect inflation to be around 2 per cent per year over the next 10 years. Then, the real interest rate is about 0.5 per cent per year for the next 10 years.
A low long-term real interest rate stimulates an economy in a number of ways. It spurs consumer spending by allowing consumers to borrow and refinance more cheaply. It makes capital expenditures and hiring more profitable for corporations. Stock prices and house prices rise because those assets become relatively more attractive as investments. Households with these assets become wealthier and demand more consumption. All of these effects should lead to less unemployment and upward pressure on prices.
So how’s it done on that front? Pretty good.
Here’s a look at 5-year yields and 5-year inflation-adjusted yields since the QE announcement. The blue line is the TIPS, the inflation adjusted yields, and as you can see, they haven’t jumped by nearly as much. Actually they haven’t jumped at all.
All that being said, it will be interesting to watch if inflation expectations turn into actual inflation, which we’ll find out soon enough, with CPI coming out on Wednesday. Last month’s was one of the most deflationary ever, so the pressure is on to actually turn the ship around.
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