Cardiff Garcia: The downsides of quantitative easing, Cardiff Garcia smackdown watch: Noted
Cardiff Garcia: The downsides of quantitative easing, Cardiff Garcia smackdown watch:
Back in July 2012, before open-ended QE was announced, Bernanke said that the Fed’s unconventional measures have “various costs and risks associated with it with respect to market functioning, with respect to financial stability, with respect to the exit process”. He wasn’t specific, and he hasn’t been more specific since.... So here is an attempt to sketch out some of the non-trivial downsides to QE, along with a discussion of countervailing arguments that explain why the downsides haven’t convinced me that QE should stop or be slowed:
QE is a flawed collateral-swap.... When US Treasuries or agency mortgage-backed securities are held by the banks, or when they are used by non-banks for repo or securities lending transactions with bank counterparties, they can be rehypothecated into longer collateral chains.... The topic of collateral chains is controversial... the case that QE is a net negative for collateral markets is strong but not definite.... It’s quite possible both that Manmohan Singh is right about the short-circuiting of collateral chains and that David Beckworth is also right about the offsetting benefits he describes in his QE counterfactual....
More QE risks trading disruptions. Buying too much of an asset’s oncoming and outstanding supply makes price discovery harder, while also threatening to impair the functioning of futures markets.... Are asset purchases in the US anywhere close to causing such disruptions yet? I don’t know....
Quantitative easing has unclear consequences for capital flows and global financial stability. IMF economists suspect that bond purchases, through the portfolio rebalancing channel, have a larger effect on capital flows from advanced economies to emerging markets than would be justified by declining interest rates.... The logical conclusion is that further QE won’t much help emerging markets, but its eventual unwinding will have a disproportionately damaging effect. Is this right? Once again I don’t know. Nobody knows, really....
QE contributes to wealth inequality, at least initially. I covered this argument in detail already and struggled with whether to include it here. A policy that consists of buying assets will, naturally, first help the people and institutions that already have assets.... So I’m going to qualify this entry as a relative downside because of how it reinforces the argument that QE is not a first-best policy. It’s what you do when other, better policies are infeasible politically.
It’s possible that not everything in the bucket list is wrong. The “bucket list” is my term for the series of complaints about QE that are commonly used but rarely well-defined. These criticisms are often lazy. In the bucket you’ll find words and phrases such as “savers”, “central bank credibility”, “artificial market distortions”, “massive balance sheet”, and, of course, “bubbles” and “hyperinflation”. Anyone who has followed the debates about QE in recent years will be familiar with the criticisms represented by these words. I find these criticisms unpersuasive. And yet... Always in the back of my head when discussing QE is the likelihood that I’m wrong, possibly about an awful lot.... Belief in one or more of the items in the bucket list is not the exclusive domain of idiots. No, I myself don’t buy these criticisms, but I do think that the very existence of the bucket list is a problem. It doesn’t prove that QE should be discarded, but it does show that QE is a policy whose comprehensive effects are widely and badly misunderstood--because they are easy to badly misunderstand. This makes the signalling mechanism, which is so important, difficult to process correctly. QE unavoidably asks the markets to do much of its heavy lifting. That the signals it sends them are so vulnerable to being mangled is therefore another downside....
I’m a peculiar choice to play spokesman for any policy associated with either fiscal or monetary tightening. Brad and I both think that QE should continue at its current pace; that QE helpfully removes duration risk; that the worries about future inflation and asset bubbles are overdone; that QE has not yet created systemic threats to the financial system; and that some of the opposition to QE is just goldbuggy derp.
Our disagreement--Brad sees no downsides and has two very good posts laying out why--does extend beyond the realm of the semantic, but perhaps not by much. Yet I also think the disagreement is instructive both about the nature of quantitative easing and about the wider debates around the policy in the past few years. Rather than an unreserved push for QE, my own case for it largely takes the shape of:
- Path dependence matters....
- What the f&%# else are we gonna do?
Fiscal policy in recent years has been atrociously restrictive and stupidly designed. The Fed has gradually lurched towards a policy-regime change along the lines of what the monetarists would want, but it doesn’t seem likely to go much further, at least for now.... Other than hoping that organic economic forces contribute to raising the natural rate of interest closer to the market clearing rate, all that’s left is the combination of an Evans Rule for rates and Quantitative Easing as a reinforcement and signalling mechanism. And the Fed’s decision regarding QE has to be judged against the context of the world we live in, not the world we wish we lived in....
Brad, I think, is trying to comfort me (and you). He’s trying to convince us that we should be happy about continued QE without any reservations. In the final analysis I do think his policy preferences have been on the side of the angels. But my reservations persist, and they are grounded in more than a desire to be considered a Very Serious Person. They won’t simply disappear to make pro-QE persuasion more convenient. I can and do accept that continued QE is necessary, but I still wish it weren’t.
