Time Duy on QE and Signalling*
Mark Thoma once claimed to be pleased that I was shrilly criticizing him. I sure hope he meant it, because here I go again. He
Update: I have trouble with reading comprehension. A one syllable name was too hard. I am commenting on Tim Duy who posted at Mark Thoma’s site. I apologize for the mistake.
Tim Duy
comments on the newly released FOMC minutes
I have long believed that the Fed failed to appreciate the signalling component of quantitative easing. Indeed, I could be convinced it was the most effective channel of transmission. I am glad to see that policymakers are starting to see that as well.
I am no longer sure whether Thoma Duy thinks that QE as actually implemented was an effective signal of future monetary policy (as I guessed when writing the comment below) or whether he thinks that a new combined strategy of forward guidance and QE at the same time with the explicit assertion that the QE means the forward guidance should be taken seriously would work.
Below I copy the comment I made based on the first interpretation and argue that QE2, QE3 and QE4 were not effective signals of future conventional monetary policy. I went to FRED and stayed there (part of the reason is I had exams to grade and FRED was one place to hide from them).
The signalling effect of QE should show up as low medium term interest rates. I think there really is no sign of this on the dates of announcement of QE2 (3 or 4 dates right there) QE3 or QE3.1 (Dec 12 2012). I don’t see it either on the day (as asset prices should respond quickly) or over an interval of time.
I really think that the hypothesis that signalling future short term rates is a highly effective component of QE is fairly easily testable and rejected by the data.
Consider QE3 announced September 13 2012 the 5 year constant maturity rate went from 0.7 on he 12th to 0.65 the 13th to 0.72 the 14th. These are tiny fluctuations. Over a longer horizon in all of September it went from 0.62% on the first trading day (Tuesday the 4th) to 0.62% on Friday the 28th. The 3 year rate declined all of one basis point on the 13th then rose 5 on the 14th (0.33 to 0.32 to 0.35) in all of September it moved not at all (0.31 on the first trading day to 0.31 on the last).
There is no sign at all of a forward guidance effect. I note QE3 included explicit forward guidance about future short term rates.
QE4 (December 12th 2012) was definitely a surprise. The 3 year rate shows no change on the 12th and up 2 basis points on on the 13th. From the first to last trading day in December it went up 2 basis points. The 5 year rate down one basis point on the 12th and up 4 on the 13th. In December overall it went up from 0.63% to 0.72%.
Again no sign of a forward guidance effect. The fluctuations are tiny, much to small to be economically significant and even too small to be statistically significant.
QE2 is harder as the announcement was telegraphed. There was Bernanke’s August 27 2010 Jackson Hole speech, the and the final announcement November 3 2010 and other announcements in between (and even the FOMC meeting before the speech). The 5 year rate went up (a bit) on August 27th and was higher the 28th than the 26th. It dropped 11 basis points from the November 2nd to 4th. This is the best news the forward guidance hypothesis and it is definitely economically insignficant. Overall from August 26th till the last trading day in November 2010 the 5 year rate went up.
I might be convinced that forward guidance is the strongest channel for QE to work, but only because I might be convinced that QE doesn’t work at all. In fact, I think that the right kind of QE would work — that so called QE would be buying 100% of new issues of RMBS at a higher than market price.
The post was written by Tim Duy, not me. (I left a comment on Robert’s blog a day or two ago as well — thought that might prompt a rewording…)
I think the only way buying RMBS would help is if the people actually paying the mortgage got a break on their payments. That ain’t gonna happen.
If the people getting the money are loaning it back to the governments, then why would interest rates change much. It’s just a big money circle jerk.
I’m not sure who Mark Thoma is.. but certainly there is/was no doubt on the part of Janet Yellen’s San Francisco FED…
OIS is our best indicator of what the market’s expectation is of FED policy over the relevant horizon..
Rudebush et.al. did the obvious.. As of course everyone who actually Trades fixed income as opposed to talks about does..
He looked at the response of OIS.. particularly 7 year OIS and 10 year OIS…in aggregate… all the QE’s.. produced nearly 100 bp’s of
“lower” rates.. i.e expectations of
a Lower OIS or FED FUNDS rate in the future..
The counterfactual is pretty obvious… and one we’ll soon be able to test..
A cessation of QE shouldn’t move rates at all if the forward guidance doesn’t change..
In the 21st Century that question will be: something like :
If I was metaphysically certain that the FED was ‘On Hold” till 2016… make that 4 years.. where should 5 year OIS trade.. or where should 4 year OIS/1 year forward trade today?
Of course this is exactly the question that the Eurodollar futures marketplace with its panoply of options on the Green/Blue/Gold and now Purple Euro’s tries to resolve every day..
Blue’s represent the markets current assesment of where OIS will be in 2017.
Stan Jonas
The Response of Interest Rates to
U.S. and U.K. Quantitative Easing
Jens H.E. Christensen
Federal Reserve Bank of San Francisco
Glenn D. Rudebusch
Federal Reserve Bank of San Francisco
QE is a deflationary exercise. It is an asset swap, and while it helps suppress long rates by a few bps helping people that can refinance, it removes a lot of interest income from the economy. When will serious economists give up on it as something that will save us.
Sorry I missed the Duy and the comment. Thanks for the link and polite correction.
The idea of buying new RMBS is that IF the Federal Housing Finance Agency acts according to its mandate of minimizing the loss to the Treasury from bailing out Fannie and Freddie, it will be willing to pay more for mortgages, since the new RMBS will sell for more (to dealers who know the Fed will pay a lot for them).
The FHFA paying more for mortgages should make banks more eager to lend so should lower the mortgage rate on new loans. This should stimulate housing sales and construction.
It sure shouldn’t affect people with underwater mortgages, although those mortgages with positive equity might benefit by refinancing.
The weak link is that the FHFA does what Edward DeMarco wants to do and his aim seems to be to minimize GDP as far as I can tell.
Stan Jonas. I stand by my analysis. Note I did not discuss QE1. My sense is that the SF Fed lumps the QEs together so the sum of the large effect of QE1 and the others says QE in general has a big effect.
I think the data say that QE1 but not the others had a big effect. Here it matters that there was a total crisis in 2008 with frozen markets. Also QE1 involved the Fed taking on a huge amount of perceived risk.
In any case estimated effects are totally different. The sum which you cite has no bearing on any claim which I actually made.
Also not Christensen and Ruderbush but Michael Bauer at the SF Fed analysed QE2 in a very creative way. He assumes that nothing much happened on August 27 2010 (the date of Bernanke’s Jackson Hole speech). Medium term rates went up that day. Instead he averaged three other dates and got a small decrease. The decrease is not statistically significant (my analysis) even with the highly creative choice of dates which don’t correspond to anyone’s narrative of QE2 and were chosen in a way which increased the estimated effect compared to the otherwise almost universal narrative.
http://www.angrybearblog.com/2012/06/qe-2-and-breakevens.html
I have been debating the research department of the SF Fed and, in particular, Yellen on this point for years http://bit.ly/101M10a. I think I have made my case (for example in this post the analysis in which you do not criticize).