I read President and CEO of the Federal Reserve Bank of Dallas Richard Fisher's speech to the National Association of State Retirement Administrators (aka, the folks who run state pension plans) and was struck by his discussion of the Gordian knot problem the Fed is faced with. Specifically, what Fisher is talking about is the timing of the Fed’s strategy to taper asset purchases.
As Fisher points out, the tapering decision is not linked to interest rates. The Fed can reduce its purchases while keeping rates at zero. This, in fact, is the most likely scenario that will play out. And as other commentators have pointed out, the objective is to change Fed policy back to a peacetime regime. The war on liquidity (since we seem to be so fond of declaring war on nebulous concepts these days) is over.
But one of the reasons Fisher wants to end those purchases sooner rather than later is illustrated by the series of charts I copied out of Fisher’s speech, which show the size of the Fed’s balance sheet and its composition.
Fisher has advocated ending quantitative easing sooner rather than later because of the size and composition of the Fed’s balance sheet, stating “we do not seem to have achieved much with the trillions of dollars we have poured into the economy through our three QE programs.”
On the surface, I’d say that is true. Unemployment has come down gradually, but not as fast as many had hoped. GDP growth has been described as “lackluster” and “sluggish.” But is that really the story? I don’t think so. And this look at the velocity of money illustrates why.
You’ll see that I drew some lines and circled some stuff since I included both MZM (the Fed’s replacement for M3) and M2. Over the past 10 years, they have both trended in the same direction: lower.
What QE and zero rates did was to stop the double black diamond ski slope downward path that the velocity of money took at the start of the housing bust. And if you think about how the economy was running at that time, that makes sense. The area I circled was the collapse in GDP and the U-turn that velocity took toward the end of the recession. That was essentially what QE bought us. The green line is simply the trend that velocity would’ve followed without the recession. So in essence, all of that money was – and is – being used to get us back to a longer-term trend line in the velocity of money that you could draw back to the end of the dot-com boom and bust.
So does that prove Fisher’s point that QE hasn’t worked, or does it refute it? Personally, I think the latter because QE did play a role in changing the rapidly-building downward momentum from the last recession. If it wasn’t done, how much more downside momentum would we have experienced? Nobody knows.
But, to Fisher’s point, we didn’t get the change in momentum this economy needed. This gap in GDP (the line in purple that represents where GDP would be without a recession) still persists:
QE has not been a panacea, and the Fed has definitely taken on a lot of risk in its balance sheet by buying all of those securities. So clearly, folks would like to see this program wind down soon.
But will Fisher get his wish to see Congress and the president work together to get reforms passed and come to agreement on fiscal policy? With a spirited debate on the next Fed chair and an election year around the corner, I wouldn’t hold my breath if I were him.
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