Has Quantitative Easing on a $5 Trillion Global Scale Paid Noticeable Benefits? I Think So…

Richard Dobbs and Susan Lund write:

The [Big] Four central banks… have injected a $4.7 trillion tidal wave of liquidity….The consensus is that these actions have raised GDP by between 1 and 3 percent and prevented a catastrophic failure in the global financial system…. Our contribution to this on-going debate suggests that… the clearest impact from ultra-low interest rates appears to have come from enabling government expenditure, and possibly boosting housing construction. Non-financial companies… have been large beneficiaries of low interest rates, saving $710 billion on their debt service costs between 2007 and 2012. However, companies have not lowered the hurdle rates they use…. Credit [remains] tight for… many small companies in the United States and Europe….

Households in the United States, the United Kingdom, and the Eurozone have lost a combined $630 billion from low interest rates as lower interest earned on deposits and other fixed income has outweighed lower interest payments on debt…. Rising asset prices prompted by QE could potentially offset this interest effect…. Bond prices have clearly risen. But we find little evidence that QE has boosted equity markets…. House prices may be higher due to low interest rates, most clearly in the United Kingdom but less so in the United States….

So where has the positive impact on growth of QE in advanced economies come from if not business investment and household expenditure? Uplift in US housing construction is one possibility…. But the clearest impact of low interest rates might be through government spending. By the end of 2012, governments in the United States, the United Kingdom, and the Eurozone had collectively benefited by nearly $1.6 trillion compared with 2007 through lower interest payments on their debt and the profits earned on expanded central bank balance sheets….

Richard Dobbs and Susan Lund are trying to gauge what the effects of the by now $5 trillion liquidity tsunami with which the Big Four central banks have hit the world economy since 2007 have been. They have six candidates:

1. The tsunami, by reducing government interest costs, has allowed governments constrained by the political system to moderate their deficits to shift spending from low-multiplier interest payments to high-multiplier government purchases.
2. The tsunami, by reducing risk premia and safe interest rates, has boosted the prices of real assets like equities and houses, and so boosted household spending out of wealth.
3. The tsunami, by reducing risk premia and safe interest rates, has boosted the prices of nominal assets like bonds, and so boosted household spending on consumption out of wealth.
4. The tsunami, by reducing risk premia and safe interest rates, has enabled businesses to invest more in plant, machinery, and equipment.
5. The tsunami, by reducing business interest costs, has enabled businesses to invest more in plant, machinery, and equipment.
6. The tsunami, by reducing household interest earnings, has caused a reduction in housed spending on consumption out of income.

Their judgement is that the tsunami has had little if any effect via (2), perhaps a small effect via (3), no effect via (4), little effect via (5), and a moderate drag via (6). That leaves (1)–crowding-in by reduced interest costs of high-multiplier government purchases by governments politically-constrained to moderate their deficits–as the only possible significant positive channel through which the liquidity tsunami could have boosted the economy after the end of the downturn and the financial crisis.

Six months ago I would have agreed with Dobbs and Lund that the effects of the liquidity tsunami–as opposed to the lender-of-last-resort guarantee, which had been effective–in boosting the recovery had been relatively small. First, I thought that the tsunami had not materially raised expectations of the future price level and so given businesses and households an incentive to raise the velocity at which they spent their liquid cash. Second, I thought that the failure of the FHFA to take Joe Gagnon’s advice and do what was needed to be done to make the HARP program effective had kept very low mortgage interest rates from materially boosting housing construction. And, third, I thought that the liquidity tsunami had had little if any effect in lowering long-term interest rates and thus boosting asset prices, reducing hurdle rates, and so raising spending.

Now I have to rethink. I still agree with Christina Romer.pdf) that the failure of the Big Four–with the exception of the Bank of Japan’s Abenomics–to frame the liquidity tsunami as part of a regime change probably hobbled its effects. And I still agree with Joe Gagnon that the failure of the FHFA to do its proper job probably disconnected the transmission belt running from mortgage rates to residential construction. But the extraordinary market reaction to the small amount of taper-talk the Federal Reserve engaged in last May and June makes me think that the liquidity tsunami has probably had a much larger effect on the course of long rates than I had previously believed. And I do strongly suspect that–hard as it is to see when you look at individual micro cases–lowered long-term interest rates exert upward pressure on every single asset price in the economy, and from there on every single spending decision.

When you look at any individual link in the causal chain, the effects of monetary policy appear tiny and insignificant. But when I reflect that the pressure is applied everywhere in the economy, and when I look at the very large interest rate reaction to even a hint that the tsunami might even start to ebb, I cannot help but be much more optimistic than Dobbs and Lund about the value of the policy.

935 words…