A Debate on the Risks of Quantitative Easing: Stan Fischer and Glenn Hubbard and Ben Bernanke vs. Joe Gagnon: Thursday Focus (December 12, 2013)
On the one side, Eric Morath reports from the Wall Street Journal's annual CEO Council:
Eric Morath: Fed Effort to Boost Growth ‘Dangerous’ But Necessary:
The Federal Reserve is in “dangerous territory” in its effort to boost growth, said [Glenn Hubbard,] a former economic adviser to President George W. Bush, but it’s hard to fault the central bank for the effort.... It does create the risk of asset bubbles....[But] “The problem is not the Federal Reserve, the problem has been the government,” said Mr. Hubbard....Rather than buying $85 billion a month in securities, the more appropriate policy response would have been a big government investment in infrastructure and other needs, he said....
Stanley Fischer, former governor of the Bank of Israel, agrees that the Fed’s early action helped avoid an even deeper crisis. He added that the Fed can successfully unwind its stimulus programs. “Everyone knows now about asset prices and presumably they’ll take that into account and moderate policy accordingly,” he said. The Fed’s actions were “dangerous, but necessary.”
On the other side, Joe Gagnon:
At Jackson Hole [in August 2012], Federal Reserve Chairman Ben Bernanke provided more detail on the “costs and risks” he had cited in his June Federal Open Market Committee (FOMC) press conference as the main reasons why the Fed has been slow to use more quantitative easing....
But the details make it clear that these costs are very small indeed, even if Bernanke was not inclined to admit it. Bernanke did acknowledge that there have been enormous costs from the unusually weak recovery.... I am concerned that an inappropriate balancing of the costs and benefits is likely to cause the Fed to err on the side of doing too little.
The first cost of quantitative easing cited by Bernanke is that the Fed could become the dominant buyer and holder of long-term Treasury and agency securities... [and so:]
trading among private agents could dry up, degrading liquidity and price discovery... [and] impede the transmission of monetary policy. For example, market disruptions could lead to higher liquidity premiums on Treasury securities, which would run counter to the policy goal of reducing Treasury yields...
But the Fed could address this problem by announcing adjustable daily targets for the yields of the securities it is buying. To hit these targets it would accelerate or decelerate its rate of purchase... giv[ing] market participants... assurance about the price for which they could buy and sell Treasury securities at any time, which is the operational definition of a liquid market.
More broadly, one of the main purposes of quantitative easing is to force investors out of the market being targeted and into other markets, which would become more liquid....
The second of Bernanke’s costs of quantitative easing is that the public might believe that it will be difficult for the Fed to tighten policy at the right time.... This fear might increase uncertainty and instability in markets. But...the key to preventing this cost from materializing is constant communication about the Fed’s intentions... inflation fears are highly sensitive to strong policy actions (or the lack thereof) in response to observed inflation....
The third cost is that low long-term yields may encourage risky behavior that threatens financial stability.... [A] monetary boost to economic recovery would reduce risks to financial stability by improving profits and decreasing the number of bankruptcies.... Some observers have argued that we are already seeing a risky bubble in the bond market. But low long-term yields are not a bubble when they are intentionally engineered by monetary policy. It is unlikely that systemically important institutions are holding excessive long positions in bonds, and it is the job of the Financial Stability Oversight Council... to prevent such behavior.
The fourth cost is the possibility that the Fed could incur financial losses on its enlarged balance sheet. Bernanke simply dismisses this cost altogether....To date the Fed has earned extraordinary profits....The Treasury also has gained both from lower borrowing costs and from higher tax revenues.... far exceed any possible losses to the Fed. And private citizens receive further benefits to the extent that quantitative easing has boosted employment.
All of the above costs combined are far smaller than the benefits from aggressive monetary easing....The Fed should promise to hold the prime mortgage rate below 3 percent for at least 12 months...
Stan Fischer's views are suddenly of more interest as the trial balloons are darkening the skies as the Obama administration tests the waters for his possible nomination to be Vice Chair for Monetary Affairs at the Federal Reserve. (No, there is not even a whisper of a hint at the Obama Administration's thinking regarding candidates for the now three-years-unfilled post of Vice Chair for Regulatory and Supervisory Affairs.) And his views appear to be the standard views among the great and good of monetary policymakers: that the current policies of the Federal Reserve are risky, and dangerous--in the current level of interest rates, in the conditional promises of the length of time interest rates will remain extraordinarily low, and the size of the Federal Reserve balance sheet. But what are these risks? What are these dangers?
I am afraid that Joe Gagnon--who does not believe in these risks and dangers--does a better job of laying out what they might be then do any of the great and good who profess to fear them. He sees four:
- low private holdings of classes of securities interfering with "price discovery" and disrupting markets;
- public fear that the the Fed will not or will not be able to tighten policy at the right time;
- low long-term yields and an absence of manageable and well0-understood duration risk to hold for yield may encourage risky behavior that threatens financial stability; and
- the possibility that the Fed could incur financial losses on its enlarged balance sheet.
And Gagnon dismisses all of them. Bernanke, however, appears to fear all of them--even though he does not quantify the dangers, and does not compare the risks and dangers of any of these four to the risks and dangers of further extending our "lost decade". Hubbard focuses on (3): risks to financial stability. And Fischer dismisses (2) and (4) and probably (1), leaving (3) as well--the fear that current policies run a risk and danger of provoking bubbles, overleverage, and overexposure to risky assets.
But none of them can point to any actually existing bubbles--save possibly in gold, which is always a bubble.
And none of them grapples with the fact that tighter monetary policy that would raise safe rates and spreads and hence make reaching for yield via assuming risk necessary has, potentially, much bigger drawbacks: nothing increases the amount of risk the private sector needs to hold as much as deflation and higher unemployment do.
I try to make sense of the implicit arguments lying behind the Hubbard, Bernanke, and Fischer risk-and-danger talk--that somehow the Federal Reserve's purchases of risky assets that diminish the amount that private-sector investors and speculators can hold increases risk--and it strikes me that I have heard an analogue to it before, in the argument that when Fannie and Freddie bought risky mortgage securities in the mid-2000s, and so took risk off the table from the private sector's perspective, they added to risk. That kind of argument made no sense to me then. It makes no sense to me now.
So what are they thinking that I am not? What am I--and the very smart Joe Gagnon--missing?