Figuring out how well the second round of quantitative easing would work wasn’t difficult, at least for one prominent economist.
Paul Ashworth, senior US economist at Capital Economics, had the Federal Reserve’seasing program, nicknamed QE2 , solved pretty much right from the start.
In a research note issued Nov. 3, 2010—the official kickoff for QE2—the Toronto-based economist pegged the central bank’s intervention “no game changer” and said an expected drop in bond yields , even if realized, would produce little actual growth.
“The Fed’s new program of asset purchases is not going to pull the US economy out of its current malaise because, given the scale of the balance sheet problems affecting household and financial institutions, it is simply too modest,” Ashworth wrote then.
At the time, Chairman Ben Bernanke had just announced that the Fed would embark on $600 billion in Treasurys purchases that he hoped would drive down bond yields and push money towards riskier investments like the stock market and real estate.
The New York Fed estimated that yields would fall about 0.50 to 0.75 percentage points as a result of QE2.
“Someone should have told bond investors, however, who are currently driving Treasury yields higher on the back of the Fed announcement,” Ashworth astutely pointed out.
In reality, from the time QE2 was announced until it ended on June 30, the yield on the 10-year note actually rose 0.51 percentage points, falling only over the past two months after a Standard & Poor’s downgrade of U.S. debt and amid worries that the U.S. is heading into another recession.
Ashworth observed that even if rates did fall, that would “do little to stimulate demand in the wider economy” because of structural problems in the housing market.
“Half of all mortgage borrowers don’t qualify to refinance at lower rates because they don’t have enough equity in their homes,” he wrote. “Larger businesses are already sitting on stockpiled cash, while small businesses who are dependent on banks are struggling to obtain credit at any cost.”
That difficulty in arranging refinancing for qualified borrowers is at the core of a plan the Obama administration has floated to push banks into redoing loans for burdened mortgage holders at today’s rock-bottom 4.22 percent rates.
With the forces of economic obstacles converging, Ashworth speculated that the Fed either would have to “admit this is a lost cause or increase the size of its purchases.” Many in the market have been betting that the Fed will exercise the latter option when it meets Sept. 20-21.
“It is easy to envisage QE2 giving way to QE3, QE4 and beyond because now that the Fed has started down this road again, it will be very hard to stop unless there are clear signs of improvement in the economy,” he added.
Reached Thursday, Ashworth said his view on QE2 hasn’t changed, but he has altered his opinion a bit on the future of quantitative easing.
That’s primarily because the Fed had an easier case to make last year when inflation was low. But with the headline Producer Price Index—which includes volatile food and energy costs—at 3.6 percent and the core PPI at 1.8 percent, inflation presents a far greater danger from Fed easing actions.
The Fed’s dual mandate calls for controlling both unemployment and inflation, which it likes to keep around 2 percent, meaning that it is already around its goal without any additional asset purchases.
“You can’t be quite as aggressive when core inflation is higher,” Ashworth said. “So possibly the Fed needs to wait a bit longer for core inflation to come down before they may be willing to go with another round of quantitative easing.”
Looking back, Ashworth still thinks QE2 was not the game changer the Fed hoped it would be, despite a modest rise in stock prices and a 0.7 percentage point drop in the unemployment rate.
“I’m sure Fed officials might very well argue that without QE2 things would be even worse. Perhaps you can make the argument that without QE2 the economy could have shrunk in the first half of the year,” he said. “The ultimate aim would have been to turn the economy on a self-sustaining path to growth. In that respect, it was a failure.”
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