Yesterday, the Federal Reserve confirmed that it would end new purchases of Treasury bonds and mortgage-backed securities (MBS)—what’s known as quantitative easing—in October. In response, the media are heralding the end of the Fed’s stimulus:
“Fed Stimulus is Really Going to End and Nobody Cares,” says the Wall Street Journal.
“Federal Reserve Plans to End Stimulus in October,” reports the BBC.
This is utterly wrong.
What the Fed is about to do is stop increasing the amount of stimulus it provides. For the mathematically inclined, it’s the first derivative of stimulus that is going to zero, not stimulus itself. For the analogy-inclined, it’s as though the Fed had announced (in more normal times) that it would stop cutting interest rates. New stimulus is ending, not the stimulus that’s already in place.
The Federal Reserve has piled up more than $4 trillion in long-term Treasuries and MBS, thus forcing investors to move into other assets. There’s great debate about how much stimulus that provides. But whatever it is, it will persist after the Fed stops adding to its holdings.
P.S. I have just espoused what is known as the “stock” view of quantitative easing, i.e., that it’s the stock of assets owned by the Fed that matters. A competing “flow” view holds that it’s the pace of purchases that matters. If there’s any good evidence for the “flow” view, I’d love to see it. It may be that both matter. In that case, my point still stands: the Fed will still be providing stimulus through the stock effect.
P.P.S. I wrote about this last year during the tapering debate. In the lingo of that post, the Fed is moving from quantitative easing to quantitative accommodation. To actually eliminate the stimulus, the Fed would have to move on to quantitative tightening.
Perhaps it also matters where one thinks the demand for dollars is. Consider the economy like a balloon: As you pour in dollars, you can get gentle overall expansion (sort of the mythical trickle-down), expansion in places (asset bubbles, overproduction) or holes where things leak out (unused dollars all over the floor – or on balance sheets of companies, China, etc.). If dollars going in are not being utilized, they are just creating an overhang rather than expansion, regardless of whether you believe in flow or stock. I wonder whether it is more that until the economy expands to the point that dollars are being invested (or misinvested), the exact Fed levels are less relevant than the fact that they are in excess…
Curiously, this leads to interesting thoughts about the role of inflation: With low inflation, there is less pressure to invest excess dollars, but if inflation ticks up, it would create high pressure to invest in order to avoid loss of value, likely leading to big bubbles.