Please help me understand QE

[muscleman]

If FED prints money to buy treasury bills, and grow its balance sheet to 4.5 trillion, then after a while, treasury will have to repay the obligations, which means FED will have 4.5 trillion cash? Then what? It can't just distribute the cash to ordinary people like you and me, so will it just keep buying more treasury bills?

These bills have interest payments, so eventually won't FED have an infinite amount of cash?

It seems to me that the stimulus effect is temporary because it is not giving treasury cash but buying bonds from treasury, and later treasury has to pay it back plus interest payment, so the higher the interest payment, the worse drain on the economy's circulating cash. Is that true?

[muscleman]

Another relatively dumb question. When did QE end? In wiki, it says QE3 ended in October 2014, but I also see this article in September 2017.

https://www.ft.com/content/caf45d6a-9e28-11e7-8cd4-932067fbf946

 

[mcliu]

I think it actually cancels out because the newly issued currency is a liability on their balance sheet which is used to purchase assets like bonds. As bonds mature, the cash asset simply offsets the liabilities.

I guess they'll earn a profit on the interest, but the excess profits will be paid back to the Treasury anyways, so they won't end up with infinite cash.

 

I think the purpose of QE is not to provide infinite stimulus but liquidity.

As liquidity improves and extreme risk-aversion subsides, the central bank can pull back and let the market take over these functions.

[muscleman]

I think it actually cancels out because the newly issued currency is a liability on their balance sheet which is used to purchase assets like bonds. As bonds mature, the cash asset simply offsets the liabilities.

I guess they'll earn a profit on the interest, but the excess profits will be paid back to the Treasury anyways, so they won't end up with infinite cash.

 

I think the purpose of QE is not to provide infinite stimulus but liquidity.

As liquidity improves and extreme risk-aversion subsides, the central bank can pull back and let the market take over these functions.

 

I know FED uses the new cash to buy treasury bills, which means treasury will have more liabilities. But how will that also be liability for the FED?

 

[maybe4less]

I think it actually cancels out because the newly issued currency is a liability on their balance sheet which is used to purchase assets like bonds. As bonds mature, the cash asset simply offsets the liabilities.

I guess they'll earn a profit on the interest, but the excess profits will be paid back to the Treasury anyways, so they won't end up with infinite cash.

 

I think the purpose of QE is not to provide infinite stimulus but liquidity.

As liquidity improves and extreme risk-aversion subsides, the central bank can pull back and let the market take over these functions.

 

I know FED uses the new cash to buy treasury bills, which means treasury will have more liabilities. But how will that also be liability for the FED?

 

When the Fed creates cash to buy bills, that cash is registered as a liability. It's simple double-entry accounting. The asset needs an offsetting liability.

 

 

[Jurgis]

So in QT, when bills mature and Fed gets cash for matured bills, do they destroy that cash?

[maybe4less]

So in QT, when bills mature and Fed gets cash for matured bills, do they destroy that cash?

 

It just cancels out. It's all digital.

[Jurgis]

So in QT, when bills mature and Fed gets cash for matured bills, do they destroy that cash?

 

It just cancels out. It's all digital.

 

Right, I understand that it's digital.  8)

[nickenumbers]

I know this is not the original direct question, but Central Banks [uS, UK, Europe] and Government Balance Sheets will never get back to the point that they were pre-great recession.

 

It was a shell game experiment executed by Bernanke [student of the great depression].  One of the alternatives was straight printing money without the offsetting government debt, but the psychology around the 2nd option [printing money] just would cause mass hysteria and diarrhea.  So, the former was determined to be the best alternative by Bernanke.

 

WEB and CM know that it was a world of very bad options, and this [cash + purchase of government debt] was one of the best of the bad options.  And there is this vague promise to "pay down that troublesome debt in the future."  <<rolling my eyes at this mock notion.>>

 

 

Do we remember the story about the emperor that had no clothes, and everyone had to pretend and play along, and say how nicely the emperor was dressed.  That is our same global monetary and national debt reality.  All of the central bankers know that the arithmetic doesn't enable the repayment of the debt, but they also know that we are all still living in our houses and drinking our Starbucks.  The numbers are so big with so many zeros, most of the world would rather have a beer and watch a sitcom instead.  So rather than ring the alarm bell for the mass population, risk revolution by the population, central bankers are more like "Meh...  I will play along if you will."

 

The US FED will attempt to show a small pay down of the debt, but when the next recession comes they will be forced to further stimulate/inflate the economy/debt.

 

PS- I don't have a better idea by the way for this problem.  I don't want to sleep under a bridge or eat out of a soup can from an open fire..  I am just semi-aware of the reality.

[Viking]

My understanding is that when QE was implemented it resulted in more liquidity which found its way into finacial assets. At the same time we had negative interest rates and this also pushed prices of financial assets higher (as interest rates fall bonds increase in value; when the 10 year US treasury yielded less than 2% this supported a higher PE multiple for the stock market).

 

We now have the opposite happening. The Fed is reversing QE, and it appears the ECB will stop QE at year end. Combined, this will result in less liquidity. At the same time we have interest rates increasing.

 

From a QE and interest rate perspective, as long as the current policy continues, it looks to me like we will see lower prices for finacial assets moving forward.

[muscleman]

So in QT, when bills mature and Fed gets cash for matured bills, do they destroy that cash?

 

It just cancels out. It's all digital.

 

Thank you! I didn't realize that when they create cash from thin air, they book a matching liability at the same time. However, since they use this cash to buy treasury bills, which pays an interest, eventually they will be paid back to cancel that liability, and at the same time, the interest payment from the treasury bills will be earnings onto FED's balance sheet, right? Am I right that this interest payment is the drain on liquidity from the economy? It makes the total amount of cash circulating in the economy less than before QE, and the interest + principal repayment to FED is the total cash reduction when we measure from end of QE to after full repayment.

 

[Guest Schwab711]

So in QT, when bills mature and Fed gets cash for matured bills, do they destroy that cash?

 

It just cancels out. It's all digital.

 

Thank you! I didn't realize that when they create cash from thin air, they book a matching liability at the same time. However, since they use this cash to buy treasury bills, which pays an interest, eventually they will be paid back to cancel that liability, and at the same time, the interest payment from the treasury bills will be earnings onto FED's balance sheet, right? Am I right that this interest payment is the drain on liquidity from the economy? It makes the total amount of cash circulating in the economy less than before QE, and the interest + principal repayment to FED is the total cash reduction when we measure from end of QE to after full repayment.

 

The Fed's excess earnings are distributed to the Treasury. In the case of QE, the Fed increased leverage, which left the expense owed to member banks relatively unchanged. Most of the interest collected from QE was returned to the Treasury.

[nickenumbers]

All,

 

From what I have read, one of the best ways to understand a nation's debt is as a ratio of GDP.

 

http://i2.wp.com/metrocosm.com/wp-content/uploads/2016/02/us-national-debt-history.png

[Cigarbutt]

Most of the money "created" ended up back at the Fed as excess reserves.

It seems then that new money did not end up circulating at the mainstreet level, which explains the absence of inflationay pressures and the absence of transmission effects on the real economy as expected by the powers that be.

 

QE contributed to lower interest rates and, by remitting the interest on public debt to the Treasury, QE helped the government to "invest" in the "recovery". It can be grossly estimated that this "profit" return to the government has contributed to a 10 to 15% decrease in the fiscal deficit. Also, it looks like the Fed has returned more than 700B this way since 2009.

 

I understand Gary Cohn said (before he moved to other personal endeavors): "If we woke up tomorrow and every central bank in the world raised their interest rates by 300 basis points, the world would be a better place.” Perhaps what he meant by "better place" sounded too much like the liquidating Andrew Mellon since the last Fed Chair alluded to the process of shrinking the balance sheet by saying she hoped the process would be akin to watching paint dry.

 

Pictures can be worth a thousand words.

http://dailybail.com/home/professor-bernanke-explains-quantitative-easing-cartoon.html

Personally, I think that, in due course, some people will have some explaining to do.

[maybe4less]

So in QT, when bills mature and Fed gets cash for matured bills, do they destroy that cash?

 

It just cancels out. It's all digital.

 

Am I right that this interest payment is the drain on liquidity from the economy?

 

 

In addition to remitting profits to the Treasury to cancel out these interest payments, they also pay interest to banks on excess reserves. Whether the banks do anything with those increased excess reserves is another story.

[Guest Schwab711]

All,

 

From what I have read, one of the best ways to understand a nation's debt is as a ratio of GDP.

 

http://i2.wp.com/metrocosm.com/wp-content/uploads/2016/02/us-national-debt-history.png

 

Fiat v. Gold Standard makes this a tough comparison. There's a lot of smaller monetary changes that further complicate this comparison over time. I don't know what I think about present debt but I don't think it's like past leverage.

[maybe4less]

Most of the money "created" ended up back at the Fed as excess reserves.

It seems then that new money did not end up circulating at the mainstreet level, which explains the absence of inflationay pressures and the absence of transmission effects on the real economy as expected by the powers that be.

 

Yes, this is exactly right. The best way to think of QE is as a mechanism of maturity transformation. There was an incredible demand for short-maturity safe assets that was driving interest rates lower. The Fed traded its short-duration excess reserves to the private sector in exchange for longer-duration assets (mostly Treasuries an Agency MBS).

 

QE contributed to lower interest rates

 

If you overlay the chart of the Fed's balance sheet and interest rates, you can see that the initiation of a new round of QE was always accompanied by an INCREASE in interest rates (In the attached I'm showing the 10-year). I think most people get the direction of causation wrong. The Fed increased its QE efforts when it felt that interest rates were getting too low and therefore deflationary pressures were getting too high.

 

(Link to graph here as well: https://fred.stlouisfed.org/graph/fredgraph.png?g=meit)

[Cigarbutt]

Fiat v. Gold Standard makes this a tough comparison. There's a lot of smaller monetary changes that further complicate this comparison over time. I don't know what I think about present debt but I don't think it's like past leverage.

Your phrase sounds alchemy to me and I need more explanation.

Do you mean:

-We can manage higher levels of debt now because we are more advanced or have better managers?

-We can simply print more money in our own currency if need be?

-We can simply suppress interest rates at will?

 

I'm asking because even if the backing has become more ill defined, I understand that fiat money remains backed, as the U.S. Treasury states, “by all the goods and services in the economy”. No?

I'm asking also because the Bank of England’s first banknotes were described as “certificates of deposit” and eventually, by the mid-eighteenth century, became “promissory notes” which maybe was the first easing step in the wrong direction. :)

The idea of income tax when introduced was that it would be temporary and history shows that it has been very hard to get rid of temporary adjustments when underlying fundamentals are left "intact".

 

One definition of a spiral:

-a progressive rise or fall of prices, wages, etc., each responding to an upward or downward stimulus provided by a previous one.

 

If you overlay the chart of the Fed's balance sheet and interest rates, you can see that the initiation of a new round of QE was always accompanied by an INCREASE in interest rates (In the attached I'm showing the 10-year). I think most people get the direction of causation wrong. The Fed increased its QE efforts when it felt that interest rates were getting too low and therefore deflationary pressures were getting too high.

(Link to graph here as well: https://fred.stlouisfed.org/graph/fredgraph.png?g=meit)

Interesting. We could "fight" back and forth with graphs forever and run into circular arguments but did you consider that whatever effects are produced by what the Fed does or is expected to do happens with a lag? What about what is going on now as we see the early effects of tightening (opposite of easing): are interest rates going down?

[JimBowerman]

 

If you overlay the chart of the Fed's balance sheet and interest rates, you can see that the initiation of a new round of QE was always accompanied by an INCREASE in interest rates (In the attached I'm showing the 10-year). I think most people get the direction of causation wrong. The Fed increased its QE efforts when it felt that interest rates were getting too low and therefore deflationary pressures were getting too high.

(Link to graph here as well: https://fred.stlouisfed.org/graph/fredgraph.png?g=meit)

Interesting. We could "fight" back and forth with graphs forever and run into circular arguments but did you consider that whatever effects are produced by what the Fed does or is expected to do happens with a lag? What about what is going on now as we see the early effects of tightening (opposite of easing): are interest rates going down?

 

maybe4less is exactly right.  Under most circumstances, large amounts of QE will result in higher interest rates (espeically when there is a lot of slack in the economy as there was during QE1 -3).  Looking at only the first order effects leads one to think that buying more of something should increase prices (and drop rates).  However, the expectation of higher inflation leads investors to start demanding higher rates.  The 2nd order effect of a central bank buying tons of bonds is to, counter intuitively, raise interest rates.  That's why Zimbabwe, Wiemar Republic, US in the early 1980s etc all had very high nominal interest rates during their bouts of inflation, despite huge amounts of bond purchases by the Fed. 

 

If rates remained low while inflation was so clearly going to rise, then you could make a killing borrowing at such low rates.  In reality, the market would adjust before you could take advantage...just not that easy to make money like that.  There wouldn't be much of a lag at all...it would be fairly instantaneous.  Furthermore, inflation would also almost instantly rise today if the Fed promised to print the $15 Trillion in 2 years time.  Again, if rates didnt' rise right away, then an investor could borrow a ton at the current low rates and make a killing when rates rose in 2 years.  This would be arbitraged out almost instantly causing rates to rise today, well in advance of the actual money printing in 2 years

 

 

With inflation its all about expectations.

[nickenumbers]

Pictures can be worth a thousand words.

http://dailybail.com/home/professor-bernanke-explains-quantitative-easing-cartoon.html

Personally, I think that, in due course, some people will have some explaining to do.

 

The cartoon of the giant pig bank eating money, and all of us hoping that rolls of money are going to pop out the south end of the pig is just FUNNY!  It makes me laugh like a little school girl..  hehehehehehehe ;D ;D

[maybe4less]

If you overlay the chart of the Fed's balance sheet and interest rates, you can see that the initiation of a new round of QE was always accompanied by an INCREASE in interest rates (In the attached I'm showing the 10-year). I think most people get the direction of causation wrong. The Fed increased its QE efforts when it felt that interest rates were getting too low and therefore deflationary pressures were getting too high.

(Link to graph here as well: https://fred.stlouisfed.org/graph/fredgraph.png?g=meit)

Interesting. We could "fight" back and forth with graphs forever and run into circular arguments but did you consider that whatever effects are produced by what the Fed does or is expected to do happens with a lag? What about what is going on now as we see the early effects of tightening (opposite of easing): are interest rates going down?

 

I mean I guess it is possible, but it's really hard to understand what such a lagged effect is on interest rates from the data we have. If you look at the three post-crisis expansions of the Fed's balance sheet, rates either went up the entire time they were buying or went up and were flat almost the entire time they were buying. Is our hypothesis that rates don't really start going down until they've finished buying Treasuries?

 

If your model for why interest rates should go down when the Fed is buying is based on a supply and demand model, then I don't think it really makes sense to consider such a hypothesis. Clearly there is something else going on.

 

To address your specific question about whether rates are going up as the Fed shrinks their balance sheet. No, they aren't, but as JimBowerman implied, inflation expectations are not low. Instead, the Fed is responding to a stronger economy and a lower demand for short-duration assets by raising rates and shrinking its balance sheet. Interest rates are determined by expectations for real growth and for inflation. The Fed is simply led by and reacts to the economy and the financial markets. (E.g., see Powell giving dovish comments this week after global growth forecasts have been revised downward and risk-assets have declined in price).

 

Another way to think about QE is that it was meant to to keep SHORT-TERM rates UP. The Fed was losing control of short-rates during the depths of the crisis due to the great demand for and the resultant scarcity of short-term safe assets. By providing more short-term safe assets, they alleviated the scarcity of safe short-duration assets and the pressure for such assets to appreciate in price, helping to stabilize the financial system and prevent further deflationary impulses. This is also why they started paying interest on excess reserves: in order to regain control over the front-end and establish a floor for short-term rates. They used to manage the front end with the the Fed Funds Rate, but it had lost its effect due to the Fed Funds market becoming essentially defunct since all the banks had all the reserves they could ever need due to QE.

[Cigarbutt]

To address your specific question about whether rates are going up as the Fed shrinks their balance sheet. No, they aren't, but as JimBowerman implied, inflation expectations are not low. Instead, the Fed is responding to a stronger economy and a lower demand for short-duration assets by raising rates and shrinking its balance sheet. Interest rates are determined by expectations for real growth and for inflation. The Fed is simply led by and reacts to the economy and the financial markets. (E.g., see Powell giving dovish comments this week after global growth forecasts have been revised downward and risk-assets have declined in price).

 

Another way to think about QE is that it was meant to to keep SHORT-TERM rates UP. The Fed was losing control of short-rates during the depths of the crisis due to the great demand for and the resultant scarcity of short-term safe assets. By providing more short-term safe assets, they alleviated the scarcity of safe short-duration assets and the pressure for such assets to appreciate in price, helping to stabilize the financial system and prevent further deflationary impulses. This is also why they started paying interest on excess reserves: in order to regain control over the front-end and establish a floor for short-term rates. They used to manage the front end with the the Fed Funds Rate, but it had lost its effect due to the Fed Funds market becoming essentially defunct since all the banks had all the reserves they could ever need due to QE.

Many ways to assess this and the picture remains fuzzy.

 

One of the difficulties is that the central banks try to control the message and the message has evolved during the QE process as rationalization to initiate and repeat the rounds has radically changed and in the end Mr. Bernanke said: "The problem with quantitative easing is that it works in practice, but it doesn’t work in theory”. :o

 

The inflation expectations aspect is interesting in theory but does not fit the data. If you look at different graphs with inflation expectations and chronologically match with the CB balance sheet, you see that the initial QE (announced end 2008) was associated with rising inflation expectations but it is not clear if there was any cause and effect (inflation expectations recovered just like after the 2001 recession when QE was discussed only in ivory towers). With QE2, there was, with some measures, a temporary spike in inflation expectations but the there was a relatively rapid return to longer term trends. With QE3, there was no positive correlation as inflation expectations diverged and continued to trend lower, a trend that has mostly continued to this day...

 

In my free time, I look at firms in distress. A common feature is that, initially, debt can be used to meet an "unexpected" problem. Then debt can be augmented to deal with lingering issues with no net positive effect and there arrives a point when more debt is counter-productive (for firms that cannot print their own currency, there may be an acceleration here). A classic case of diminishing returns (digging yourself in a hole).

It seems to me that the central bankers realized that additional rounds of QE were simply not effective because the system was flush with excess reserves and because, effectively, of the the liquidity trap that you describe without naming it.

 

The way to deal with this may have been to come upfront about it but, for obvious reasons, the CB came out with the rational that a deflationary spiral had been avoided. The big question I have is: was it avoided or simply postponed?

 

A potential interpretation of yesterday's wording may be that there is more postponing in store.

Mr Bernanke, when explaining the evolving rationale behind QE often mentioned the risk of losing public confidence and I wonder if that risk has not been underestimated.

 

Contrarian opinion: The emperor has no clothes.

Potential personal bias: tendency to overestimate lag effects.

"Clearly there is something else going on." You bet.

 

I hope this discussion continues but I have reached my diminishing return level of contribution for this topic.

 

[Guest Schwab711]

Fiat v. Gold Standard makes this a tough comparison. There's a lot of smaller monetary changes that further complicate this comparison over time. I don't know what I think about present debt but I don't think it's like past leverage.

Your phrase sounds alchemy to me and I need more explanation.

 

Do you mean:

-We can manage higher levels of debt now because we are more advanced or have better managers?

yes and no

-We can simply print more money in our own currency if need be?

yes

-We can simply suppress interest rates at will?

no

 

I'm asking because even if the backing has become more ill defined, I understand that fiat money remains backed, as the U.S. Treasury states, “by all the goods and services in the economy”. No?

I'm asking also because the Bank of England’s first banknotes were described as “certificates of deposit” and eventually, by the mid-eighteenth century, became “promissory notes” which maybe was the first easing step in the wrong direction. :)

The idea of income tax when introduced was that it would be temporary and history shows that it has been very hard to get rid of temporary adjustments when underlying fundamentals are left "intact".

 

One definition of a spiral:

-a progressive rise or fall of prices, wages, etc., each responding to an upward or downward stimulus provided by a previous one.

 

 

If I could explain it well, I wouldn't be writing for free :). I'll try my best. The smaller monetary changes are things like: (1) during the 1820's/30's, each bank in the US issued their own currency, the US temporarily allowed both silver and gold coins, and Congress fubed the silver:gold exchange ratio. It was hard to issue debt; (2) There were debtor prisons in the US up until 1850 ish; (3) The Civil War introduced a temporary income tax and depending on if Confederate debt is counted, you have a half gold standard/half fiat value during that period; (4) From the Civil War to 1912, the largest counterparty in the US was a private bank; (5) 1944 Bretton Woods fixed currencies and allowed the US to dominate the global economy for 25 years, which brings us to today.

 

As I try to simply answer below to semi-highlight that I think reading in to the meaning of 'not comparable' too much inflates what I mean, I think fiat is simply different than gold standard, similar to floating FX being different than pegged FX. No system is perfect or guarantees good times forever. A gold standard system bounds the value of currency and is more prone to deflationary spirals, from what I've understood. Fiat is unbound and less prone. Less prone doesn't mean immune. For 100+ years we never had double-digit inflation on more than a temporary basis. With a fiat system, we had double-digit inflation in the first couple of years. In an unbound and inflationary-tending environment, more debt can be supported, ceteris paribus.

[maybe4less]

To address your specific question about whether rates are going up as the Fed shrinks their balance sheet. No, they aren't, but as JimBowerman implied, inflation expectations are not low. Instead, the Fed is responding to a stronger economy and a lower demand for short-duration assets by raising rates and shrinking its balance sheet. Interest rates are determined by expectations for real growth and for inflation. The Fed is simply led by and reacts to the economy and the financial markets. (E.g., see Powell giving dovish comments this week after global growth forecasts have been revised downward and risk-assets have declined in price).

 

Another way to think about QE is that it was meant to to keep SHORT-TERM rates UP. The Fed was losing control of short-rates during the depths of the crisis due to the great demand for and the resultant scarcity of short-term safe assets. By providing more short-term safe assets, they alleviated the scarcity of safe short-duration assets and the pressure for such assets to appreciate in price, helping to stabilize the financial system and prevent further deflationary impulses. This is also why they started paying interest on excess reserves: in order to regain control over the front-end and establish a floor for short-term rates. They used to manage the front end with the the Fed Funds Rate, but it had lost its effect due to the Fed Funds market becoming essentially defunct since all the banks had all the reserves they could ever need due to QE.

Many ways to assess this and the picture remains fuzzy.

 

One of the difficulties is that the central banks try to control the message and the message has evolved during the QE process as rationalization to initiate and repeat the rounds has radically changed and in the end Mr. Bernanke said: "The problem with quantitative easing is that it works in practice, but it doesn’t work in theory”. :o

 

The inflation expectations aspect is interesting in theory but does not fit the data. If you look at different graphs with inflation expectations and chronologically match with the CB balance sheet, you see that the initial QE (announced end 2008) was associated with rising inflation expectations but it is not clear if there was any cause and effect (inflation expectations recovered just like after the 2001 recession when QE was discussed only in ivory towers). With QE2, there was, with some measures, a temporary spike in inflation expectations but the there was a relatively rapid return to longer term trends. With QE3, there was no positive correlation as inflation expectations diverged and continued to trend lower, a trend that has mostly continued to this day...

 

In my free time, I look at firms in distress. A common feature is that, initially, debt can be used to meet an "unexpected" problem. Then debt can be augmented to deal with lingering issues with no net positive effect and there arrives a point when more debt is counter-productive (for firms that cannot print their own currency, there may be an acceleration here). A classic case of diminishing returns (digging yourself in a hole).

It seems to me that the central bankers realized that additional rounds of QE were simply not effective because the system was flush with excess reserves and because, effectively, of the the liquidity trap that you describe without naming it.

 

The way to deal with this may have been to come upfront about it but, for obvious reasons, the CB came out with the rational that a deflationary spiral had been avoided. The big question I have is: was it avoided or simply postponed?

 

A potential interpretation of yesterday's wording may be that there is more postponing in store.

Mr Bernanke, when explaining the evolving rationale behind QE often mentioned the risk of losing public confidence and I wonder if that risk has not been underestimated.

 

Contrarian opinion: The emperor has no clothes.

Potential personal bias: tendency to overestimate lag effects.

"Clearly there is something else going on." You bet.

 

I hope this discussion continues but I have reached my diminishing return level of contribution for this topic.

 

I think it's important to reiterate that interest rates are made up of two components: inflation expectations AND real return expectations. 

 

I don't disagree with your analysis of inflation expectations versus the Fed's balance sheet. But real rates started dropping towards the end of QE1 and continued to drop (with some small bumps) straight through QE2, even though inflation expectations increased. (That the spikes in both inflation expectations and real rates during QE2 were transitory is why we got QE3.) Inflation expectations didn't move all that meaningfully after QE3, but we got a big pop in real rates that has persisted. (See attached chart.)

 

The relative stability subsequent to QE3 in both inflation expectations and real rates is likely why the FED has not felt that QE4 was necessary.

[Cigarbutt]

I think it's important to reiterate that interest rates are made up of two components: inflation expectations AND real return expectations. 

 

I don't disagree with your analysis of inflation expectations versus the Fed's balance sheet. But real rates started dropping towards the end of QE1 and continued to drop (with some small bumps) straight through QE2, even though inflation expectations increased. (That the spikes in both inflation expectations and real rates during QE2 were transitory is why we got QE3.) Inflation expectations didn't move all that meaningfully after QE3, but we got a big pop in real rates that has persisted. (See attached chart.)

 

The relative stability subsequent to QE3 in both inflation expectations and real rates is likely why the FED has not felt that QE4 was necessary.

Thanks for your response.

In all frankness, the graph you provide could be interpreted in so many ways… If you add another layer about expected expectations it would even be possible to take the modern monetary theory seriously. :)

I will follow you in this rabbit hole and then try to provide perspective.

 

Maybe it's my scientific background bias and expectation that 2+2 usually gives 4 but if 1-easing was used to prevent real interest rates from falling too low and 2-easing eventually caused a "big pop" (more on that later in the perspective), then why tightening has been accompanied by increasing real rates? Why doing opposite things cause the same result? There are a huge number of potential answers and I suspect which one you will come up with. ;)

 

In terms of perspective (looking outside of the time frame of your graph), real interest rates (which are tied to potential GDP growth) have been convincingly coming down since the early 80's (not only in the US BTW) and this is for another thread to discuss but the blips we have seen in the last few years have not changed that trend unless one believes that the times they are changin'. I try to supplement posts with factual or corroborating evidence and I could have supplied you with solid work that contains however derogatory comments but here's one from the Master himself:

https://www.brookings.edu/blog/ben-bernanke/2015/03/30/why-are-interest-rates-so-low/

 

Look, he says, I did what I could and it's up to the other actors to play their role. One of the things that bothers me is the comment, which I agree with, that punctual government spending could cause a short term increase in real interest rates. Mr. Bernanke made those comments in 2015 and perhaps did not envision that the recent administration would put the pedal to the metal in terms of government spending and fiscal deficits in a late cycle. The major thing that bothers me though is that this easing program was to give time to the powers that be to deal with the secular forces and to allow a "beautiful" deleveraging. Deleveraging, what deleveraging? As I sip my coffee in late 2018, we are, on a net basis, on more shaky grouds for debt especially at the public and corporate (hypertrophied BBBs, leveraged loans, high yield etc) levels than 10 years ago. And now we are "ready" for tightening?

 

Sorry long post.

 

Maybe4less, you seem to have an interest in maturity transformation. For a historical parallel, alchemists involved in metal transformation (they called it transmutation then) used the scientific fact related to the differential density of lead and gold. Gold creation was a myth but alchemy was both practice and philosophy. Have you taken a look at which end of the curve the Treasury is selling its debt issues? There is an obvious connection to monetary easing (or absence thereof) as the fiscal/monetary firewall is being tested. An interesting side effect of the tightening mode is that the Fed has been (and will be more and more?) absent from government auctions and, even if the supply of government debt has considerably increased lately, the Treasury, in its great wiseness, has preferentially and to a large extent gone for the 2 year-auctions versus the 10 year-auctions: YTD: 2yr + 55%, 10yr +26% thereby conducting the equivalent of a fiscal operation twist. In my humble experience, for the typical firm with rising debt, short term refinancing may be an ominous sign but I'm just a guy paying his bills every month. Interesting times.