Conferences & Events

2014 Financial Markets Conference

April 2014

Quantitative Easing (QE) Lover or Hater?

Panel Session Highlights with:
Dave Altig, Federal Reserve Bank of Atlanta
Allan Meltzer, Carnegie Mellon University's Tepper School of Business
Jeremy Stein, Federal Reserve Board of Governors
David Zervos, Jefferies LLC

Dave Altig: So the topic of the first panel this morning is essentially devoted to the question of whether QE is friend or foe, or your crazy cousin who's annoying but kind of benign otherwise. QE, of course, in its current guise, is winding down even as we speak, but I think that the issues that will come up in the discussion are relevant to accommodative policy more generally, and certainly looking down the road when the wind down of QE becomes, the balance sheet part of the QE, becomes relevant.

Allan Meltzer: It will be no surprise to anyone who knows me to know that I think that QE started off on the right foot and then got sidetracked into what can only be described in a word that I use very advisedly—a foolish program.

And the Fed has no coherent plan that it's announced about how it's going to get rid of $2.5 trillion worth of reserves.

There has never, ever been a country anywhere in the world that produced large budget deficits and financed them by money growth that didn't end up in inflation.

What would I do instead? I would have taken the interest rate if it was going to go to zero, it certainly would have gone to zero for the excess reserves that were being produced by the Fed that took the excess reserves, the idle reserves of the banking system from up to $2.5 trillion. I would not have done that. I would have paid zero interest and allowed the money growth rate to rise instead of trying to hold it back.

And when the asset prices rise, that means that the relative price of new production is low so you get new production of investment. That hasn't happened. That's one sign, one of many that we have a real problem in the American economy, a serious set of real problems, but not a substantial monetary problem.

Because the Fed pursues a policy of following noisy indicators and making it the most important thing in the minds of the market, the market pays attention to the noisy indicator.

The main problems of the American economy, I repeat then and I believe now, are real problems that the Fed cannot touch. Those are the problems of the uncertainty about future tax rates, about how we're going to deal with the $75 trillion to $100 trillion, depending upon the discount rate you use, of unfunded liabilities, what happens to regulation—the excessive regulation, which the administration puts on.

Jeremy Stein: I'm going to sidestep a little bit the QE as crazy-cousin formulation, and what I'm going to try to do is talk a little bit about the question of how one might go about incorporating financial stability considerations into a monetary policy framework.

I'm not suggesting—and this is to a point that Professor Meltzer just made—I'm not suggesting financial stability as another mandate for the Fed. The Fed has its hands full, agreed, certainly insofar as monetary policy goes, with unemployment and inflation.

It's not like financial stability has an independent weight, unconditionally; it's going to depend where you are on the spectrum relative to full employment.

Monetary policy shouldn't be doing a job that's better left to regulation—I absolutely agree with that.

Regulation is not perfect, and all you need to make the argument for monetary policy is that regulation doesn't do the job 100 percent.

All else equal, monetary policy ought to pay attention to risk premia in the bond market.

Here's a fact, here's a simple, totally agnostic fact, which is for all this kind of bubble this and bubble that talk, academic finance is very largely in agreement around the proposition that there are movements in these risk premia and that you can use data to have some significant objective forecasting power.

(Referencing charts) This is an extension of some work that my colleague at the Board Egon Zakrajsek has done with Simon Gilchrist just showing that credit risk premia have a lot of forecasting power for future economic activity. So movements in credit risk premia tend to portend changes a year down the road, changes in GDP [gross domestic product] and unemployment. So the only thing that I have added to their analysis here is to show you the asymmetry of this relationship. So what these figures do is look separately at the effect on the right-hand side here of increases in credit risk premia—so this is, crudely speaking, increases in credit spreads—and, on the other side, on the left-hand side, decreases. And what the pictures are trying to tell you, I'll just say the words, is that it's completely asymmetric. So that is to say that when credit spreads rise, there is a pretty powerful (I won't say anything about causality), but it's associated with a pretty powerful negative effect on GDP and on unemployment.

But that's the central fact about finance, is these risk premia moving all around. At the same time, if you look at macro models of the sort that are used to inform our policy decisions, they have none of that in them. They basically have constant risk premia and everything is sort of the term structure is the expectations hypothesis. That feels to me like what we can do better.

David Zervos: What's happening in credit markets? And I put a couple of charts up here because I want to address some of the points that Jeremy [Stein] made earlier. The first chart is just total U.S. system credit debt as a percentage of GDP, which has been falling, and the growth rate of U.S. system credit debt year over year, which has been well below average. This is everything—household, corporate, government. Debt is not expanding. We are not in a credit bubble. Households are deleveraging; financial corporates are deleveraging. Yes, nonfinancial corporates are leveraging up somewhat, but the overall system credit is going down, or is stabilizing at a lower percentage of GDP growth.

There will be another bubble, I can almost guarantee it. But I've come to believe that that bubble doesn't come from monetary policy, that bubble comes from the natural overzealousness of markets.

I'm an unabashed lover of QE. I think QE has done amazing things. I think Ben Bernanke has taken enormous risks that have produced amazing returns.

If you allow deflation to enter the system and you allow real rates, the risk-free real rate to rise after people lose enormous amounts of their wealth, you are effectively paying them not to take risks.

And in Japan, for 20 years after the 1989 crash, the Bank of Japan allowed risk-free rates to stay positive. So Mr. and Mrs. Watanabe were sitting at the breakfast table, but their conversation was, "We lost 70 percent in our stock portfolio, and we lost 70 percent in our house." And then you turned around and you ran a monetary policy that paid people not to take risk. What do you get out of that? Two decades lost, that's what you get. We avoided that.

There are side effects to QE; QE is not a free lunch. There are potential issues with conducting monetary policy this way, and I think Allan [Meltzer] said it earlier, we are effectively conducting the greatest monetary policy experiment in history and no one—no one in this room and no one outside this room—really knows how it's going to end.

And we had mistakes with the dosage on the way up. We didn't get the dosage right on the way up, we're not going to get the dosage reductions right on the way down.

I think as Ben [Bernanke] said at Bard College in a speech a little over a year ago, "This is the greatest time to be an innovator; the incentives to innovate have never been greater," and I actually believe that's what the Federal Reserve gave us. The Federal Reserve gave us nothing in the real economy. They didn't produce anything, and they don't produce anything. The only thing they do is change our incentives.