As detailed earlier in the month, the Federal Reserve announced more stimulus, otherwise known as QE4, at its recent meeting.

Lots of the discussion thus far has focused on whether or not QE will happen and not on the purpose of QE.

What we discuss below is a good example of economists discussing the probability of QE rather than why QE is necessary or what it will accomplish.

So, what is QE supposed to do?  Bernanke told us in his speech over the summer in Jackson Hole:

“After nearly four years of experience with large-scale asset purchases, a substantial body of empirical work on their effects has emerged. Generally, this research finds that the Federal Reserve’s large-scale purchases have significantly lowered long-term Treasury yields. 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.12 Three studies considering the cumulative influence of all the Federal Reserve’s asset purchases, including those made under the MEP, found total effects between 80 and 120 basis points on the 10-year Treasury yield.13 These effects are economically meaningful.

LSAPs also appear to have boosted stock prices, presumably both by lowering discount rates and by improving the economic outlook; it is probably not a coincidence that the sustained recovery in U.S. equity prices began in March 2009, shortly after the FOMC’s decision to greatly expand securities purchases. This effect is potentially important because stock values affect both consumption and investment decisions.

While there is substantial evidence that the Federal Reserve’s asset purchases have lowered longer-term yields and eased broader financial conditions, obtaining precise estimates of the effects of these operations on the broader economy is inherently difficult, as the counterfactual–how the economy would have performed in the absence of the Federal Reserve’s actions–cannot be directly observed. If we are willing to take as a working assumption that the effects of easier financial conditions on the economy are similar to those observed historically, then econometric models can be used to estimate the effects of LSAPs on the economy. Model simulations conducted at the Federal Reserve generally find that the securities purchase programs have provided significant help for the economy. For example, a study using the Board’s FRB/US model of the economy found that, as of 2012, the first two rounds of LSAPs may have raised the level of output by almost 3 percent and increased private payroll employment by more than 2 million jobs, relative to what otherwise would have occurred.15

This is not the first time the Federal Reserve has laid out this argument.  In a November 4, 2010 Washington Post op-ed, the day after QE2 was approved, Ben Bernanke defended their actions with the following passage:

Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

Federal Reserve Board Chairman Ben Bernanke said Thursday that a controversial $600 billion bond buying plan has contributed to a stronger stock market. “Our policies have contributed to a stronger stock market just as they did in March 2009 when we did the first iteration of this program,” Bernanke said at a Federal Deposit Insurance Corp. forum on small businesses. “A stronger economy helps small businesses more than larger businesses. Interest rates are higher but that’s mostly because the news is better. It has responded to a stronger economy and better expectations.”

To sum it all up:

• The Federal Reserve buys Treasury bonds in order to push down interest rates, making them an unattractive investment (last shown here, page 6) .

• Investors respond by moving out the risk curve and buying assets like corporate bonds and stocks, pushing them higher.  The Federal Reserve believes this happens via the portfolio balance theory.

• But according to the Federal Reserve, moving out the risk curve does not include buying agricultural or crude oil futures, so do not blame them for higher food or gasoline prices.

• Higher asset prices create a wealth effect, which increases spending and confidence and improves the economy. The Federal Reserve believes this has helped create 2 million jobs.

We agree with half of what is written above.

• QE does produce lower interest rates, or at least the belief that rates are too low.  This then pushes investors out the risk curve which is why stocks have such an immediate and positive reaction whenever QE is speculated.

• The Federal Reserve is playing politics in regards to the effect of QE on commodity prices.  There is no reason to believe the risk curve ends at low-rated stocks.  How much QE affects food and gasoline prices can be debated, but to argue there is no effect at all, and will never be an effect under any scenario, merely because the Federal Reserve does not want to answer for these higher prices, is just wrong.

• The argument that higher asset prices produce a wealth effect is only partially correct.  Two conditions must be met for a wealth effect to ensue.  Net worth must reach a new high and it must be perceived to be permanent.  This is why housing produced such a powerful wealth effect before 2006.  Home prices always went up and their gains were perceived to be permanent.  Currently we have a retracement of losses and a widespread distrust of financial markets.  These conditions will not produce any wealth effect and we believe they have not.

QE is great for Wall Street as it produces more volatility (brokers like this), higher stocks prices (fund managers like this) and draws lots of attention (analysts like this).  It is not good for Main Street because it does not create wealth.  QE’s effects are not perceived to be permanent, so it does not lead to higher GDP or job growth.

What Will The Federal Reserve Do?

In Septmber we noted that the median expectation in a survey of primary dealers calls for $500 billion of additional purchases heavily tilted toward mortgage-backed securities.   If the purpose of QE is to push stock prices higher, then the Federal Reserve has to deliver at least $500 billion in purchases.  Otherwise it will disappoint risk markets.

Right now, if we have to guess, we believe the Federal Reserve will announce purchases of less than $500 billion. In January the Federal Reserve adopted an inflation target of 2.0%.  As we detailed in a conference call last month, inflation expectations are running well above this target.  One measure of inflation expectations, the 10-year TIPS inflation breakeven rate, is shown below.  Further, in April, when Bernanke was asked if he would adopt a suggestion from Paul Krugman to expand the target to 3%, he flatly rejected the idea.

The hawks will argue expected inflation is too high to add more stimulus, an argument which will carry some weight.  The compromise will be a program of less than $500 billion in purchases which will disappoint the markets.

Click to enlarge:

Source: Arbor Research

For more information on this institutional research, please contact:

Max Konzelman

Category: Federal Reserve

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

26 Responses to “What Is The Purpose of QE?”

  1. rd says:

    QE has had some benefit, but nowhere near what it should have been given the unprecedented magnitude of the central bank intervention.

    1. Companies will only invest if they see a future return regardless of interest rates. With low demand, they are not investing at the rate they should be and unemployment remains high so much of that part of the prupose of QE is failing.

    2. Much of the demand comes from the portion of the population making less than $100k. They have little in the way of equity investments, and so they unaware that they are supposed to be feeling a “wealth effect.”

    3. There have been house refinancings that have occurred. However, much mortgage debt is for underwater homes that can’t be refinanced. Meanwhile, the very low interest rates are not being passed on in more common forms of consumer debt, such as credit cards which still generally have interest rates in the mid to high teens.

    4. Much of the population over 65 has savings that pay interest (or used to). They have watched their income plummet over the past 4 years.

    5. The wealthy have the assets that increase in value with QE. They are not primary demand generators as much of their excess earnings and wealth are simply saved since their is a limit on what they actually want to spend money on.

    6. Commodity prices are clearly kept high, especially oil and food, by QE. This has been a transfer of wealth from the 90% to the people who produce commodities.

    The initial QE made sense as an initial stop gap measure. However, it seems that the repeated execution of it is having fewer and fewer benefits but distorting the markets more and more. At some point there has to be a recognition that it is currently just another form of trickle down economics that has failed in numerous incarnations over the past three decades, including the claims that tax cuts pay for themselves, lower capitals create investment, and lower tax rates for the “job creators” and “makers” result in higher employment.

    Unfortuantely, the deficit means that cessation of the QE would likely drive borrowing costs for the US government up substantially, so the entire country is becoming addicted to QE.

  2. The USA has been in a Structural Depression since Aug/2007. SGDP is -6% today. Make no mistake that deflation would be rampant had not the QE’s & OpTwist not been implemented. RGDP has been a manipulated mirage over the past five years and is only a function of the trillion dollar Deficits. There is a chance QE will be lifted when the Unemployment Rate hits 6.5% in early 2015, but if Congress attempts to trim the Deficit to below $1 trillion, QE will be continue to be necessary to maintain status quo.

    TRI charts:

  3. louis says:

    The system is broken, The Junkies are in charge.

    Merry Christmas all.

  4. Willy2 says:

    I have a different view on the reason of QE. And this comes on top on what BR has said.

    The US has been running a Current Account Deficit since 1950 (!!!). It needs to do so because the USD is the world’s reserve currency. This is detrimental to the US because the US is then actually bleeding money (deflation). In order to lure that money back to the US, the US needs to entice investors to return that money/those USDs back to the US. And that requires ….. Rising Asset Prices (commodities, stocks, bonds, real estate) !!!! But Benny Bernanke can’t keep asset prices this levitated for ever.

    And those foreign investors are also the reason why the US government bailed out a number of banks. A lot of money has fled the US but still sits in US banks. And that money abroad sitting in US banks effectively props up the US financial system. Those banks going belly up would have effectively starved the US financial system.

  5. barbacoa666 says:

    For people low income people who live paycheck to paycheck, I don’t see much of a direct benefit.

    As a somewhat small investor with some capital available, QE (really just Operation Twist) helped me finance rental property at extremely low interest rates. I also am refinancing my home at an extremely low rate. I also own stocks and bonds. So clearly, QE has benefited me. But not in a big way.

    A friend of mine who has extremely wealthy investors for customers points out that QE enables the very wealthy the access what are essentially taxpayer-subsidized loans to acquire large amounts of property. Craft people, architects, etc., do benefit from these transactions. People who are disadvantaged include existing, competing property owners, who find themselves up against a competitor with what some may consider an unfair advantage.

    So to me, it looks like QE is another trickle-down program, and works to increase the wealth divide.

    If you wanted to boost the economy, I would suggest sending out $1000/dependent tax refunds. That would make a real difference for many, at relatively low cost to the country.

  6. sparta47 says:

    Why call it stimulus? If it is stimulus then compared to all other recessions it is a failure.

    Why not call it what it is? Artificial PRICE CONTROL on the cost of capital.

    Price controls over an extended period of time have proved to be failures.

    Why not call artificially low rates, even negative real rates on the short end: The Transfer of Real Wealth From Savers to Borrowers. Who Suffers? Who Gains?

    Price Controls MisAllocates Capital.

    The investment in Real Assets that produce jobs is more contingent on demand than one or two interest points.

  7. algernon says:

    What of all the harm resulting from money print?

    Distortion of relative prices makes efficient allocation of resources impossible.

    Monetizing Federal debt ‘enables’ Federal debt to balloon beyond the level of possible repayment (in a way impossible if the govt could only borrow from people with real savings).

    Senior citizens tied to CDs & safe bonds are badly hurt. Ditto for insurance companies. Value is taken from them for the benefit of those being bailed out by artificially low interest rates.

    By contrast the wealthy with a high proportion of financial assets, the finance industry, & the govt–that is to say, those who get 1st dibbs on the freshly created money–are enriched compared to the masses. Herein is a big subject for those interested in the trends in incomes of rich vs. poor. Indeed, there is great irony that the govt–justifying itself as helping the poor vs. the rich–does just the opposite with our fascist banking system.

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  10. Jim67545 says:

    I view this as an attempt, back in 2009, to stabilize the housing industry and to benefit the banking industry by reducing/attenuating the mortgage disaster and reducing their cost of funds. Perhaps it did exactly that and it was the right remedy at the time. But with the recovery taking an unexpected length of time, my questions are, should QE be stopped as no longer appropriate and is the Fed trapped in a policy they see no way to exit?

    There are at least three undesireable effects of QE. First, it has permitted legislators to do nothing about the GSEs and the broken secondary market mortgage situation. Consequently the Fed is stuck buying the mortgage flow. Second, the low cost of funds over time has been met with low interest income so the fat net interest margins that helped banks initially is fading. This takes time to swing from one side to another and even when things pick up the lower rate assets on the banks’ balance sheets will be a legacy of this period.

    Thirdly, there is the damage done to the retiring boomers and the next generation. Delayed retiring by the boomers has increased Gen Y and other cohorts’ unemployment. Many have opined that for someone in their 20s who is unable to establish a career path reflecting their qualifications for their first decade or so in the workforce, they will see reduced income throughout their working careers. A decade or two from now we will have to deal with starving boomers who have exhausted their savings/income partly as a result of the recession and the poor interest rates available during this period.

    All of this has been written about here and elsewhere. The point is that while QE may have been good, even necessary, medicine for the first 18 months, as time goes on its positive impact fades and its negative effects grow.

  11. RW says:

    That we are still in the midst of QE is a testament to several things:

    1. The financial crisis was far larger and deeper than normal and there was no possibility of anything like a normal recovery, particularly in the absence of extraordinary and coordinated monetary and fiscal policy response.

    2. That the fiscal response was insufficient is a testament to the fecklessness of Congress, the context insensitive campaign against deficits and countercyclical policy, and the widespread refusal of elites to recall the lessons of the Great Depression or appropriately respond to the manifest needs of the under- and unemployed.

    3. The FOMC majority is now reasonably convinced that QE now longer has significant benefit unless expectations change so they have committed themselves to fostering a less expensive $USD with no terminal date so those hording cash (mainly corporations) will no longer see benefit in doing so.

    The larger context includes something along the line of Willy2′s point but it would take too long for a blog comment so suffice it to say that national accounting differs from regular accounting in several important areas including budgeting and it is national accounting that both the Fed and Congress is really responsible for.

    NB: Every time I hear some beltway jackass declare we need a balanced budget Amendment to the Constitution I am torn between howls of laughter and a strong desire to rid the world of another jackass. It’s one thing for tea-party types to believe this sort of foolishness — no reason to expect them to understand national accounting — and quite another for someone actually responsible for federal policy to believe it or even give it lip service (and yes Obama, I am looking at you!).

  12. mad97123 says:

    When rates eventually do rise, maybe years out, the losses suffered from the QE bond bubble will may all others look trivial, and we’ll all look back and wonder why it wasn’t obvious this was the lasting impact of QE.

    Very little talk about the Morals in creating all this Moral Hazard. The standard reply “it would have been worse without it” has yet to be proved, and will only be known years from now.

  13. Concerned Neighbour says:

    I’d agree with sparta47 that there is a lot of misallocation of capital going on right now. We’ve got blue chips that are barely growing trading at mid-20′s P/E’s and huge book value multiples. And don’t get me started on AMZN (the stock, not the company). I like to joke that after a few more QE’s, JNJ and the like will have P/Es of 3,000+.

  14. socaljoe says:

    My take on QE…

    The purpose of QE is to finance the deficit and to show potential US treasury buyers that there is a buyer of last resort with unlimited means to put a floor under the market. The hope is that this will keep the bond vigilantes in hibernation and prevent a failed auction or a sudden spike in rates, in which case it would be game over… default and depression or print and hyperinflation… possibly ending in a new hard asset currency.

    Any other stated purpose (stimulate the economy, reduce unemployment, etc.) is political cover.

  15. Mark A. Sadowski says:

    “QE is great for Wall Street as it produces more volatility (brokers like this)…”

    Day to day price change data for stock market indices is available at FRED.

    Here are the daily index changes in percent for the Dow Jones Industrial Average (DJIA) (5/26/1896-12/24/2012):

    And here is the daily price changes in percent for the S&P 500 (SP500) (1/2/1957-12/24/2012):

    Now, the large expansion of the Fed balance sheet occured after 9/10/2008, QE1 was announced on 11/25/2008 and concluded on 10/31/2009, QE2 was hinted at on 8/27/2010 and concluded on 6/30/2011, Operation Twist was announced on 9/21/2011, and QE3 was hinted at on 8/31/2012. Using these dates it is possible to divide each dataset of daily stock index changes into nine periods and calculate the standard deviation of daily stock index changes for each of the periods:


    MEP refers to the Maturity Extension Program (Operation Twist).

    It’s true that volatility was higher than normal during 9/11/2008-11/24/2008 and during QE1 but it was lower than normal during QE2 and QE3. And over the period from November 2009 on forward the two periods with the highest stock market volatility have actually been those when there was no QE or MEP at all.

  16. jus7tme says:

    The purpose of QE is mostly to allow big banks to sell their junk MBS mortgage bond holdings at a high price, so that they can use the money they get for it to turn around and front-run the rest of the people by buying other assets at depressed prices (houses, stocks, whatever).

    But the Fed needs something (meaning a “money” equivalent) to give to the banks in exchange for the MBS. This “something” is US treasury bonds, which is generally viewed to be equivalent to printed money. And where does the Fed get the Treasury Bonds from? By monetizing new federal debt.

    So QE is an unholy alliance of The US, The Fed and The Banks, all at the expense of 99% of taxpayers.

    Why does never get stated out loud? I think people simply do not understand what QE *really* is. Any benefit to unemployment and demand is just a small sideshow.

  17. Frilton Miedman says:

    Both Jim, and more so – RW have said everything I’d say.

    All this Fed QE is reactionary to piss poor Fiscal, tax and regulatory policies.

    (I’d add that low rates are saving our asses on debt service.)

    Of the list of erroneous policy RW lays out, this is what happens when you run an economy the way you run a corporation.

    You cannot fire citizens then expect them to just go away and find another job the way it happens in the private sector.

    This is the mistake of Austrian economics, every single citizen falls into one of two categories within an economy

    - an Asset, or a liability.

    The guy who was riveting I-beams on infrastructure projects five years ago, making $30K, paying taxes and consuming, is now collecting unemployment, welfare or some other social entitlement, if he cannot find a job that pays adequately to feed his family, he could eventually wind up resorting to desperate measures, ending with incarceration.

    Any of the above converts him from an economic asset to a liability

    The Dave Kochs out there have absolutely no concept of this, they’re insulated from real life, they make massive assumptions that an economy works the way a corporate balance sheet works – and they’re running our country behind closed doors.

  18. Mark A. Sadowski says:


    The average volatility during QE2 was 0.78.

    The average volatility during QE3 has been 0.76.

  19. Mark A. Sadowski says:

    “…higher stocks prices (fund managers like this)…”

    It is well known that there is normally little correlation between US inflation expectations and US stock prices. Higher inflation might boost stock prices if associated with growing aggregate demand, but higher inflation can also lead to expectations of tight money, or higher taxes on capital, since capital income is not indexed. Indeed the high inflation of the 1970s seems to have depressed real stock and bond prices. In general, the stock market seemed content with the low and stable inflation of recent decades, at least judging by reactions to changes in inflation expectations.

    After 2008 stock prices became strongly correlated with inflation expectations from the TIPS markets. David Glasner documented this pattern, which is actually pretty obvious to anyone who followed the TIPS spreads and equity prices in recent years.

    Stocks and TIPS spreads became highly correlated after 2008 because the economy’s main problem was too little nominal GDP, and higher inflation expectations were correlated with higher NGDP growth expectations. Prior to 2008 higher inflation merely had no effect on real returns.

    Glasner looked at 8 years of data, from January 2003 until December 2010, and divided the sample up into 10 sub-periods. He found almost no significant correlation between inflation expectations (TIPS spreads) and stock prices (S&P 500) until March 2008. (Actually, there was a modest positive correlation during the first half of 2003, another period when people worried about excessively low inflation.) After March 2008, the correlation was highly significant, and positive. Right about the time where the US began suffering from a severe AD shortfall, the stock market began rooting strongly for higher inflation. And it still is, even in the most recent period. Money is still too tight.

    There is no way to overstate the importance of these these findings. The obvious explanation is that low inflation was not a major problem before mid-2008, but has since become a big problem since.

    The Fisher Effect under Deflationary Expectations
    By David Glasner
    January 2011

    “The response of nominal and real interest rates to expected deflation becomes problematic when nominal interest rates fall toward zero while the expected rate of deflation is increasing. As nominal interest rates approach their lower bound, further increases in expected deflation cannot cause the nominal rate to fall. Either the Fisher equation is violated or the real rate must increase. One way for the real rate to rise is for asset prices to fall. Regressions between 2003 and 2010 of the daily percentage change in the S&P 500 on the TIPS spread measuring inflation expectations show little correlation between asset prices and expected inflation from 2003 until early 2008. However, since early 2008 the correlation between changes in stock prices and in inflation expectations has been strongly positive and statistically significant.”

  20. Mark A. Sadowski says:

    It’s probably worth mentioning that the only other period in US history that a positive correlation has been found between inflation and stock returns was the 1930s, a period often characterized as an example of a liquidity trap.

    Monetary policy, stock returns and inflation
    By Ding Du
    January-February 2006

    “The relationship between stock returns and inflation depends on both the monetary policy regime and the relative importance of demand and supply shocks. A simple analytical framework by which to empirically examine the relative importance of these two factors is developed in this paper. Our findings indicate that the positive relationship between stock returns and inflation in the 1930s is mainly due to strongly pro-cyclical monetary policy, while the strong negative relationship of stock returns and inflation during the period of 1952–1974 is largely caused by supply shocks that were relatively more important in that period. Our results are broadly consistent with the general economic literature on monetary policy and stagflation.”

  21. DeDude says:

    The mandate of our central bank requires that it fight unemployment (and therefore the recessions that causes unemployment). Normally this fighting of downturns is a partnership between the Fed and lawmakers. Whenever republicans or democrats really want to increase GDP they do so with child tax credits or other types of programs that quickly and directly puts money in the pockets of the consumer class, so we know that both parties are fully aware of what it takes to increase growth. The last downturn was unusual not just in its size but also in the fact that one of the two parties refused to try countering it with true pro-growth measures. As a result the Fed not only faced an unusually large downturn but also was left without the partner it usually has to help get the economy and employment growing again. Continued QE is the desperate attempt of the Fed to “go it alone”. If the Fed were given the choice of getting some real pro-growth policies from congress in exchange for not doing any more QE they would do it in a minute. They know QE is getting less and less effective although they are convinced that the positive effects (in particular on housing) are still able to outdo the negative effects (on commodities and income for small savers).

  22. obijohn says:

    The purpose of QE is simple: kicking the can down the road.

    Any fool can see that there is not enough surplus capital lying around out there to finance the US annual deficit when it is well above $1 trillion… even Bernanke. What then does a Fed Chairman do when the US government is trying to sell debt that no one can buy? What happens when the world realizes that the US is flat broke, busted, bankrupt? When that day happens, the house of cards will collapse, the US will lose its current status as the world’s reserve currency, our foreign creditors will realize to their dismay that they will not get repaid, and all hell will break loose.

    Bernanke has been playing a desperate game, hoping that the political leadership of the US will get its act together before the forced day of reckoning, and propping up the dead horse in the meantime. Of course, all this assumes that the party running the majority of the government really cares about destroying the US economy… and so far that doesn’t seem to be the case. There will be no deal on the fiscal cliff, and the debt ceiling battle is looming. What will happen when we hit the hard stop, when the Fed can no longer postpone the inevitable because the Treasury can’t legally issue more T-bills? Maybe the Mayans were a little off, maybe it’s all coming to a head about a month after they figured it. At this point, selling SPY and buying GLD looks like a winning strategy.

  23. DeDude says:


    If the GOPsters refuse to allow more printing of T-bills Obama have these choices:

    1. Use his constitutional powers to defend the currency and just issue them anyway.
    2. Stop printing T-bills and instead print as many $ bills as he need (its about time we test MMT).
    3. Close down government and military activities in all the Tea-baggers districts until they cry Uncle.

    Default is not an option and will not be needed. Nor is there any limit to how many T-bills and agency bonds Bernanke can and will purchase in order to keep interest rates down. If the Chinese want to sell their T-bills and have their currency appreciate drastically – then go ahead make my day. If every fool in the world wanted to sell their T-bills Benny would just purchase them all – what is to stop him and what is the harm? Those who fight the Fed will lose, because paper is so much cheeper than gold.

  24. DeDude says:

    Forgot the most powerful one:

    4. Delay payment of social security checks for a few days (until he gets permission to borrow the money that covers them).

  25. [...] cliff. The incomes of the rich have largely recovered thanks to bank bailouts, stealth transfers, ‘Quantitative Easing’ that lifts financial asset prices and ongoing government guarantees of the financial system, while the incomes of the lower 99% have [...]