Well, we have it now. The FOMC has promised (or threatened, depending on your viewpoint) to:
–Extend the low-interest policy through mid-2015
–Purchase $40 billion of agency MBS per month indefinitely
–Confirm “Operation Twist” to year-end
–Continue its easy policy well into the eventual recovery period
The most significant part of the program is its open-ended nature rather than a fixed amount or time period for its asset purchases. The longer terms for MBS will add to its long-term security purchases to expand long-term assets by $85 billion per month at least through the term-extension program through the end of the year. The least significant part of the policy is the promise of easy money through mid-2015, which can be rescinded if the opportunity arises, and the confirmation of operation twist through the end of the year.
An important feature of the program was not stated explicitly, but that is that the $40 billion of MBS purchases will not be sterilized but will be allowed to expand the Fed’s balance sheet. Contrary to conventional wisdom, net Fed assets have not increased for about 18 months and money-supply growth has not been excessive for the circumstances. When the talking heads speak of the growth in Fed assets of about $2 trillion, they usually neglect to mention that all of that growth took place by mid-2011 and that there has been no net growth since then. They also neglect the fact that operation twist is by definition a sterilized program.
As I write this, the latest Federal Reserve H.6 money supply numbers show that, in the 3 months ending in July 2012, M2 grew at a 6.5 percent annual rate. The 6-month growth rate was 5.6 percent. The 12-month growth was 8.1 percent. These are hardly excessive growth rates under present circumstances, and they have been offset by declines in the velocity of money. (The money-growth percentage added to the income velocity-growth percentage equals the percentage growth in nominal GDP.)
A couple of initial observations:
The term “quantitative easing” was created to refer to easing measures once interest rates have declined to the lowest levels achievable by policy measures. Quantitative refers to the quantity of money, credit, bank reserves and the like, not to interest rates. Therefore, it’s beside the point to evaluate its impact by what its announcement does to the term structure of interest rates. Of course, Mr. Bernanke has contributed to that confusion by touting the interest-rate impact of the actions.
Many talking heads have been saying that that QE1 and QE2 didn’t do any good; so why should a QE3. I submit that they don’t really mean to include QE1 in their assessment. That was the program to unfreeze frozen financial markets in the aftermath of the financial crisis. Surely, there must be consensus that those actions were absolutely necessary.
I would also argue that QE2 was also helpful even though most of the asset purchases ended up expanding excess reserves of the banking system rather than passing through the banks to create more money as intended. If the banks felt they needed such a large quantity of excess reserves and the Fed hadn’t provided them, the banks, as they did during the Great Depression, would likely have tried to get them by shrinking their other assets, including loans.
Critics talk about the “cost” of the Fed’s actions without acknowledging the benign nature of those costs. The Fed is not using taxpayer money for the purchases. They are, in effect, paying for them with newly created bank reserves and perhaps a small amount of newly created deposit money. The taxpayers actually benefit since the extra earnings from the Fed’s larger portfolio are remitted to the Treasury and thus reduce the taxpayer cost of servicing the debt. I acknowledge that under normal circumstances this might amount to monetizing the debt and creating inflation, but these are not normal circumstances. Not only is money growth moderate, but inflation is falling as well.