Has The Fed Misjudged The "Continuous" Effects of QE?
Has the Federal Reserve misjudged the "continues" effects of quantitative easing (QE)? QE is an extension of the Fed's interest rate policy. But it influences financial conditions by purchasing assets (mainly government bonds and other fixed-income assets) from the private sector. The stock of assets purchased, not the flow, matters. That means even when the Fed stops buying assets or tapers, it is still doing "QE" or easing monetary policy as long as the Fed balance sheet remains exceptionally big as it is nowadays.
Former Fed Chair Ben Bernanke, the father of QE, stated, "Central bank purchases of longer-term financial assets (QE) have proved to be an effective tool for easing financial conditions and providing economic stimulus when short rates are at their lower bound. The effectiveness of QE does not depend on its being deployed during a period of market turbulence".
That last sentence is interesting because neither Mr.Bernanke nor any other Federal Reserve official has ever examined the deployment of QE or its continual existence when policymakers try to reverse monetary accommodation and fight an inflation cycle.
Several studies found that during the initial Q3, when the Fed's balance sheet exploded to over $4 trillion from around $500 billion when it started and promised to anchor official rates, it lowered long-term rates by 150 basis points. Professor of Economics William Kuttner at Williams College estimated that the drop in long-term yields was the equivalent of 450 basis points of Fed easing. That's huge.
The Fed balance sheet is now twice as big after the second QE program following the pandemic. Does that mean the current level of QE on the fed funds is twice as big as the first phase, or 900 basis points? Does the easing effect from QE increase or decrease the larger the size of the Fed's balance sheet?
Answers to these questions are most important because they would clarify what level of fed funds is needed in the new world of QE. Policymakers' silence on this issue makes it clear that they don't know, which raises the risk of investing.
Investors should be aware that we are in a new era of monetary policy as the Fed is tightening with one tool (official rates) and easing with another (QE). Still, it's hard to make the case that monetary policy is tight following the blowout reports on jobs and consumer spending. The blended effect on the overall stance of monetary policy needs to be clarified.