End of an Era? Monetary Policy and Currency Issues in 2014: QE or not QE?
GIC Policy Conference London, UK May 8, 2014
Your basic QE chart: Yep, the balance sheet is large.
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QE: The users guide.
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Bottom line: Not all QE is born equal.
QE1: The credit policy version.
QE2: Pure form QE. QE3: Cheap-talk insurance.
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QE1 – A program during full-on crisis. Dollar LIBOR to OIS* Spread 400 350 300
Basis points
Lehman Fails 9/08 Bear Stearns Fails 3/08
*Overnight Index Swap rate
LSAP I begins (11/08)
250
The Crisis 200 Begins 8/07 150 100 3-month 50
1-month
0 Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
Jan-11
Jul-11
Jan-12
Jul-12
Jan-13
through February 26, 2013 Source: British Bankers Association/Bloomberg
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Why we call it LSAP: The Fed’s balance sheet grew by less than half the size of the “QE.”
Ultimate size of QE1 program: Better than $1.7 trillion Increase in balance sheet, November 2008-June 2010: Less than $2.5 billion
In the end, QE1 purchases mainly replaced the emergency credit facilities. Federal Reserve Assets (Uses of Funds) $ billions
3,000 2,700
Currency Swaps
The Fed’s asset purchases of Treasuries (the green area) and MBS (the red area) mainly replaced the disappearing alphabet-soup lending facilities.
Agency Debt & MBS Lending to Nonbank Credit Markets
2,400
Short-Term lending to Financials Other
2,100
Treasuries
1,800 1,500 1,200
900 600 300 0 Dec-07
Jun-08
Dec-08
Source: Federal Reserve Board of Governors
Jun-09
Dec-09
Jun-10
Dec-10
Jun-11
Dec-11
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A couple of selective (but representative) QE1effect estimates. Authors
Estimated Impact
Krishnamurthy and Vissing-Jorgensen (2011) Hancock and Passmore (2011)
Treasury effects: -107 bps MBS effects: -85 bps announcement effect on mortgage rates, -50 bps on actual purchases
Sources: http://www.frbsf.org/economicresearch/files/KrishnamurthyVissingJorgensen.pdf, http://www.federalreserve.gov/pubs/feds/2011/201101/201101pap.pd f 8
With the deflation scare, QE looks like QE. Monetary Base Billions of dollars, seasonally adjusted 3500000
QE2
3000000 2500000 2000000 1500000 1000000
QE1
500000
Unlike QE1 – which was weighted to MBS purchases – QE2 was a Treasury-only program
0
Source: Federal Reserve Board of Governors
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The QE2 environment: Falling inflation, falling expectations. 3.6
Bernanke hints at QE2
QE2 commences
3.4
Inflation swaps
3.2
3.0 2.8 2.6 2.4
TIPS 2.2 2.0
Jan-10
May-10
Sep-10
Jan-11
May-11
Sep-11
Jan-12
May-12
Sep-12
Jan-13
May-13
Sep-13
Jan-14
May-14
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Deflation probabilities (derived from TIPS) jumped in summer 2010, and subsequently moderated. Probability that reference CPI in 2015 will be lower than today Percent 40
August 25, 2010 35 30
November 2010 FOMC meeting
25 20 15 10 5 0 Apr-10
Jul-10
Oct-10
Source: FRB Atlanta calculations
Jan-11
Apr-11
Jul-11
Oct-11
Jan-12
Apr-12
Jul-12
Oct-12
through January 13, 2013
The important lesson of QE2: Talking is doing (if you mean it). Bernanke hints at QE2
3.6
QE2 commences
3.4
Inflation swaps 3.2
3.0 2.8 2.6 2.4 TIPS
TIPS
2.2 2.0
Jan-10
May-10
Sources: Federal Reserve Board, Bloomberg
Sep-10
Jan-11
May-11
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The seed of the new era: Twist and shout.
August 2011: Communications enhancements • Specified interest rates are expected to remain low until mid-2013 (extended to late 2014, then mid-2015, then…) September 2011: Maturity Extension Program (Operation Twist), MBS Rollover
• $400 bil. purchase of long-term Treasuries, “sterilized” by sale of short-terms; maintain size of MBS portfolio (extended to end of year in June)
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The “twin pillar” era (rapidly coming to a close).
September 2012 - present: Open Ended LSAP; forward guidance • Open-ended MBS purchases at pace of $40 billion per month starting in September • MEP replaced by outright purchases of longterm securities in December • Forward guidance – “shout” replaced by explicit unemployment and inflation thresholds (also in December)
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Proof in the pudding? LSAP stocks versus LSAP flows. 10-year Treasury yield weekly
4.25% 4.00% 3.75%
Taper announcement
3.50% 3.25% 3.00% 2.75% 2.50%
Bernanke Testifies to Congress
2.25% 2.00%
June FOMC Press Conference
1.75%
1.50% 1.25% Jan-13
Apr-13
Source: Federal Reserve Board
Jul-13
Oct-13
Jan-14
Apr-14 through May 1, 2014 15
An alternative explanation: Woodford rules. Forward guidance is key when the policy rate is at its lower bound provided: •There is a credible commitment to stay the course longer than would prescribed by “normal” policy • Credibility should be supported by verifiable, state contingent triggers LSAPs may work, but only if : •There is unusual market segmentation • Purchases reinforce commitment to low rates See: Michael Woodford, “Methods of Policy Accommodation at the Interest-Rate Lower Bound”, http://www.columbia.edu/~mw2230/JHole2012final.pdf
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End of an Era?