Saturday, September 01, 2012

Debating Bernanke

Ben Bernanke who knows a lot more on the topic than I do claims that there is fairly strong evidence of stimulatory effects of Large Scale Asset Purchases LSAP also known as QE.  I have persistently noted that I   have found little evidence of such an effect of QE II as opposed to QE I. The first two LSAPs were very different, because the assets purchased were very different (also financial conditions were very different).  In QE I the Fed bought mortgage backed securities MBS.  At the time investors were terrified of MBS.  In QE II the Fed bought 7 year Treasury notes -- the asset closest to money which had a noticeably positive yield.  By Bernanke's reasoning about LSAT, QEI should have been vastly more effective per dollar created

His principal argument is

Imperfect substitutability of assets implies that changes in the supplies of various assets available to private investors may affect the prices and yields of those assets. Thus, Federal Reserve purchases of mortgage-backed securities (MBS), for example, should raise the prices and lower the yields of those securities; 

although he goes on to argue that "Large-scale asset purchases can influence financial conditions and the broader economy through other channels as well."

Note "MBS" in Bernanke's discussion of how LSAP might work.  Note that he didn't write "7 year Treasury Notes" or "30 Year Treasury Bonds."   

When he discusses the effects of LSAP Bernanke tends to lump QE I QE II and operation Twist together. There are a few exceptions 

 For example, studies have found that the $1.7 trillion in purchases of Treasury and agency securities under the first LSAP program reduced the yield on 10-year Treasury securities by between 40 and 110 basis points. The $600 billion in Treasury purchases under the second LSAP program has been credited with lowering 10-year yields by an additional 15 to 45 basis points.

He then notes that estimates of the sum of the effects of the three programs are economically significant.  I do not think a 15 basis point decline in the 10 year rate is economically significant.  The evidence cited by Bernanke does not, according to Bernanke, include proof that QE II had an economically significant effect.  Even 45 basis points is very small compared to the effects of aggressive normal monetary policy (and I mean effects on the 10 year rate).

Then Bernanke writes

Importantly, the effects of LSAPs do not appear to be confined to longer-term Treasury yields. Notably, LSAPs have been found to be associated with significant declines in the yields on both corporate bonds and MBS.14 The first purchase program, in particular, has been linked to substantial reductions in MBS yields and retail mortgage rates. 

My bold. What a shocker buying MBS causes reduced mortgage rates (what we need) while, if buying 7 year notes and 30 year bonds did anything like that, Bernanke didn't bother to mention any evidence.

There it is, probably the worlds number one expert on the topic (before he became Fed chairman) and he relies on lumping together programs which, by his own logic, were very different.

Note that when he discusses what's wrong with the economy Bernanke doesn't mention anything that would be noticeably helped by a 15 bp or even a 45 bp reduction in the 10 year rate.

 I see growth being held back currently by a number of headwinds. First, although the housing sector has shown signs of improvement, housing activity remains at low levels and is contributing much less to the recovery than would normally be expected at this stage of the cycle. Second, fiscal policy, at both the federal and state and local levels, has become an important headwind
Third, stresses in credit and financial markets continue to restrain the economy. Earlier in the recovery, limited credit availability was an important factor holding back growth, and tight borrowing conditions for some potential homebuyers and small businesses remain a problem today.  [snip stuff on Europe]

OK we have "housing"  and "some potential homebuyers and small businesses" .  This sure doesn't sound like a problem with the 10 year Treasury rate.  Sounds to me rather specific to housing.  Seems to me to be a no brainer that future LSAPs should be of MBS. 

Can Bernanke explain why QE II consisted of purchases of 7 year notes ?  Can anyone  ? Is there any conceivable logic ?

I say the evidence, as presented by Bernanke, suggests that buying MBS works.  

He barely kinda sort of claims that buying long maturity treasuries had an economically significant effect, but he doesn't present evidence which, if taken at face value, proves that claim.


Peter said...

Krugman tells us that Woodford believes - tentatively - that QE worked through the expectations channel.

"Woodford parses the evidence, and concludes tentatively that most of the apparent effects of QE actually come through the expectations channel — that is, that QE works, to the extent it does, largely because markets see it as a form of forward guidance."

" I do not think a 15 basis point decline in the 10 year rate is economically significant. "

Could this be analogous to conservative criticisms of Obama's stimulus? It depends what your baseline is. Just because the economy isn't back up to trend growth, doesn't mean the stimulus didn't work to the extent it did given its size relative to the economy.

Robert said...

It is not analogous to conservative criticisms of Obama's stimulus. Advocates of further fiscal stimulus argue that the ARRA added about $1,000,000,000,000 to US national income. No one claims that $1,000,000,000,000 is economically insignificant.

In contrast I know of no one, except perhaps for you, who claims that a reduction of interest rates of 0.15% is economically significant. Bernanke certainly made no such assertion -- he claimed that the combined effect of QE I, QE II and operation twist on interest rates was large enough to be economically significant.

Notice that I am accepting at face value the estimates cited by Bernanke. Note that Bernanke didn't assert that QE II had an economically significant effect. He clearly claimed that QE I had a significant effect and that the sum of the effects of QE I, QE II and QE III was significant.

Your analogy is similar to asking if I agree that a minnow is about as big as a whale.