Wednesday, July 6, 2011

Impact of QE2

The second round of quantitative easing (QE 2) in the US by the Fed, involving $600 billion in Treasury-bond purchases over the past eight months, came to an end on 30th June. However, the Fed will not start exiting from its expansionary policy and will remain committed to holding its balance sheet at its present size by among other things, reinvesting the proceeds of any securities that mature while in their possession.

At first reading, in terms of its direct objectives, the QE 2 was a success - interest rates on long-term securities and corporate bonds declined, asset values rose, dollar depreciated, and deflation worries abated without igniting undue inflationary pressures. However, in terms of achieving its final outcomes, its impact was less obvious - corporate spending remains depressed, consumer and business confidence is still weak, and economic growth and unemployment are dismal. The WSJ has an excellent graphic that captures these trends.

Like other interventions during this crisis, QE 2 too faces questions about its effectiveness. Critics point to the persistent recessionary conditions to claim that monetary expansion did not succeed. Its supporters argue that QE 2 backstopped the economy from slipping further, and claim that the situation would have been much worse without QE 2. They also point out that the recovery has not been strong because the monetary expansion was itself inadequate.

Mostly Economics points to an excellent presentation by James Bullard, President of the St Louis Fed, who illustrates graphically how events unfolded after Ben Bernanke's Jackson Hole speech in August 2010 - expected inflation rose, dollar depreciated, real interest rates declines, and equity prices rose. See also this from a St Louis Fed seminar on quantitative easing.

In any case, it can be safely argued that the QE 2 program atleast prevented the economy from getting worser and may also have set the economy on the recovery path, both of which would have not been possible without monetary expansion.

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