"I WROTE in this week’s issue that unconventional monetary policy of the sort the Federal Reserve promised on December 16th "is often called 'quantitative easing' because its effect is felt through the quantity rather than the cost of credit."
The Federal Reserve has disputed that its actions are "quantitative easing", the term given to policies the Bank of Japan implemented earlier this decade once its interest rate had fallen to zero. I disagree. Here is my rationale:
The difference between quantitative easing and conventional easing is that the first occurs through the size of the balance sheet and the second through the level of the short-term interest rate (although a purist would note that changing the level of the interest rate ultimately requires an adjustment in the size of the balance sheet also). Growth in the balance sheet can occur through either the liabilities (that is, bank reserves and currency) or the assets (holdings of securities and loans); the two ultimately must equal. While a central bank can try to achieve its effects differently by targeting reserves versus targeting assets, I think they're both ultimately a way of achieving monetary stimulus through the quantity rather than the cost of credit( OK ). The fact that the Fed has not put specific figures on how much it will grow the balance sheet to me is not significant; until 1989 it didn't put specific figures on how much it was changing the federal funds rate, either, but that was still clearly the focus of its monetary policy.
I discussed this over email with Peter Hooper, the chief economist at Deutsche Bank Securities, and he disagrees. He writes:
I would quibble with the notion that what the Fed is doing now is, strictly speaking, quantitative easing, though I wouldn't say you are wrong. This is a matter of semantics. I just look at things, or at least define them, a bit differently. First, I wouldn't say that changes in the size of the Fed's balance sheet would necessarily signal the kind of special quantitative easing we are talking about. I will acknowledge that it is tempting to define any large increase in the balance sheet as quantitative easing, but I prefer to be more of a purist on this.
As you note, the purist would say that any time the Fed eases it is a "quantitative" easing. That is, when the Fed eases (reduces its rate target), it involves increasing the quantities of both the assets and the liabilities on its balance sheet (assuming demand for reserves at any given rate has not declined)—ie, it buys Treasuries and issues more reserves. I would define the special case of quantitative easing we are talking about the way Ben Bernanke did in a speech not too long ago: as the central bank pushing out more reserves than are demanded at a zero interest rate.( OK )
Prior to its recent move to paying interest on reserves, the Fed had to guess what quantity of reserves to issue to meet demand at the rate it was targeting. Now, with interest being paid on reserves at its target rate, in principle at least, it doesn't have to guess on the quantity, it simply supplies all the reserves that are demanded at that rate. I say "in principle", of course, because there is a glitch—the GSEs hold reserves but are not eligible to receive interest from the Fed, so they do indirectly through banks at a discount, and that discount has been significant because banks are unwilling to expand their balance sheets to take advantage of the full amount of this arbitrage opportunity. The discount is what has pushed the effective federal funds rate below the target rate and explains why the Fed has moved to a range rather than a point target. It could fix the problem by paying interest on reserves held by GSEs—this would raise the effective rate to the rate paid on reserves (25 bps currently). But this is taking us aside a bit from our debate.
The Fed is now supplying all the reserves that are demanded at a still positive price through its various liquidity facilities. To my way of thinking, this still differs significantly from what I think of as the more aggressive form of quantitative easing pursued by the Bank of Japan. The BOJ set an explicit target for reserves that it knew would be well in excess of banks' demand even at a zero interest rate. It did so in hopes that banks would begin to use the glut of reserves to expand their lending, but this was clearly a case of pushing on a string—the banks just sat on the reserves.
The Fed is now taking a quite different tack and, I think, potentially much more productive one. It is aiming to reduce elevated credit spreads by purchasing GSE MBS (as well as by offering non-recourse loans against ABS when the TALF gets going). (Note that the BOJ would not have considered this option because it was not facing the kind of elevated credit spreads we have today. They also were facing a much more severe deflationary situation and had fewer options than the Fed.) What the Fed is doing may look and feel like quantitative easing in terms of its impact on the balance sheet, and because it now involves outright purchases of securities, it looks more like what the BOJ was doing. But so long as the Fed is still paying positive interest on reserves (even with the GSE-related slippage), I think it is a different animal. There is also an important difference in motivation: It is an effort to influence market interest rates directly rather than an effort to increase bank lending via increasing the quantity of reserves being supplied.
It is true that the stock of excess reserves has soared, and that looks a lot like what happened in Japan, but I would maintain that in the US case, the stock of excess reserves is still a reflection of a tremendous increase in demand for liquidity on the part of investors and financial institutions. The cost of that liquidity obtained through the Fed's various lending facilities is nonzero, and to the extent that further increases in the stock reflect Fed purchases of MBS going forward, the move is aimed explicitly at reducing rates, not increasing quantity. Hence, I would not call this a pure "quantitative easing" a la BOJ or per Mr Bernanke's definition, which I think is a reasonable one. What I would call it is an aggressive application of unconventional monetary policy, and an appropriate one under the circumstances."
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