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Saturday, September 15, 2012

Extreme claim on QE III

QE III is not just a shift towards more use of the expectations channel.  Aside from being open ended it is also qualitatively different from QEII, that is the quality of the MBS to be bought is lower than the quality of the 7 year Treasury notes bought as QE II.  There has been no shift from confidence in portfolio balance to confidence in expectations.

Also there is no evidence of any change at all in expected future monetary policy.  This evidence should appear as soon as the news in announced.  Lower expected future federal funds rates should cause lower expected 5 year T-bill rates which should cause lower 5 year T-note rates by now.

From Wednesday close (before the announcement) until Friday close (latest data) the 5 year rate changed 0.00 % (in fact it increased by 0.oo2 % so I am being charitable to those who think QE III is working through the expectations channel -- but that really is a microscopic tiny miniscule insignificant change in the wrong direction).

Now I admit that my approachof focusing on changes over 48 hours and then declaring the matter settled is not the same as the approach of Michael Woodford, the leading advocate of the focus on the expectations channel.  In his huge paper, he analysed transaction by transaction data and only looked at the day of the announcement.  Stretching out the horizon to 48 whole hours is cheating (otherwise I would report a big big but statistically insignificant and economically totally utterly insignificant decline of 5 whole basis points). 

To claim that the question is still open, however, would require those who stress the importance of the expectations channel to argue that a statistical method is perfectly fine when it gives them results of the sign they like (although always of trivial magnitude) but invalid when it gives the answer they don't like.    

To be as rude as possible, if they don't admit they were wrong (and I was right about the potential on Wednesday for further future guidance) their reasoning is like the argument that defence spending creates jobs but ARRA spending doesn't.  

By Woodford's rules, the debate is over and he lost.

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