From John Cochrane's The Grumpy Economist blog:
Slok on QE, and a great paper
DB's Torsten Sløk writes in his regular email analysis:Yesterday I participated in the annual US Monetary Policy Forum here in Manhattan, and the 96-page paper presented concluded that we don’t really know if QE has worked. This was also the conclusion of the discussion, where several of the FOMC members present actively participated. Nobody in academia or at the Fed is able to show if QE, forward guidance, and negative interest rates are helpful or harmful policies.Despite this, everyone agreed yesterday that next time we have a recession, we will just do the same again. Eh, what? If we can’t show that a policy has worked and whether it is helpful or harmful how can we conclude that we will just do more next time? And if it did work, then removing it will have no consequences? There is a big intellectual inconsistency here.These lovely paragraphs encapsulate well the academic and industry/policy view, and the tension in the former.
Investors, on the other hand, have a different view. Almost all clients I discuss this topic with believe that QE lowered long rates, inflated stock prices, and narrowed credit spreads. Why? Because when the Fed and ECB buy government bonds, then the sellers of those government bonds take the cash they get and spend it on buying higher-yielding assets such as IG credit and dividend-paying equities. In other words, central bank policies lowered risk premia in financial markets, including in credit and equities. As QE, forward guidance, and negative interest rates come to an end, risk premia, including the term premium, should normalize and move back up again. And this process starts with the risk-free rate, i.e. Treasury yields moving higher, which is what we are observing at the moment.
I'm interested by the latter tension: Industry and media commenters are deeply convinced that the zero interest rate and QE period had massive effects on financial markets, in particular lowering risk premiums and inflating price bubbles.
I'm deep in the academic view. The industry view forgets that the Fed does not just suck up bonds, it issues interest-bearing reserves in exchange. For every $1 of bond the market does not hold, the market has to hold $1 of additional reserves. Industry analysis is very insightful about individual traders and investors and the mechanics of markets but forgets about adding up constraints and equilibrium which are the bread and butter of academia. You personally may sell a bond and put the money in to stocks. But someone else has to sell you that stock and hold the reserves....MUCH MORE