May 25th Weekly Economic Update

We gave the Federal Reserve’s (Fed) quantitative easing (QE) a passing grade for lowering financial market and banking stress levels in last week’s Weekly Economic Commentary, “Grading the Fed’s QE Program: A Multi-Week Group Project,” May 18, 2015). Why grade the Fed now? We have just passed the six-month mark from the last purchase of QE3, which began in September 2012 and ended in October 2014. Also this week, colleges, universities, and high schools pass out report cards and hand out diplomas, so we’ll grade the Fed on its dual mandate — granted to the Fed by Congress in 1977 — to promote low and stable inflation and maximum employment.


As part of our grading process, we’ll compare the performance of inflation and employment before, during, and notably, six months after the end of Q3; as well as before, during, and after the Fed’s first two forays into QE: QE1 (November 2008 through March 2010) and QE2 (November 2010 through June 2011). We’ll complete the grading in the next Weekly Economic Commentary by assessing the performance key sectors of the financial market — a key transmission mechanism for QE from the Fed to the rest of the economy. As we assess the Fed, we point out that Operation Twist came between QE2 and QE3, making it much more difficult to grade either of them on their own merits. Operation Twist was aimed at putting downward pressure on long-term Treasury yields without the Fed buying any additional net Treasures. It sold existing holdings of short-term Treasuries (less than three-year maturity) and bought longer-term Treasuries (6 – 30 years in maturity).

The Fed cannot control either inflation or employment directly of course, and can only use its policy tools to foster an economic environment that will lead to low and stable inflation and maximum employment. For most of its history, the Fed used some combination of the money supply, reserve requirements (money the Fed requires banks to hold against their deposits), and interest rates to nudge the economy toward the goals of the Fed’s dual mandate. However, in December 2008 — in the aftermath of the collapse of Lehman Brothers and the near freeze-up of the global credit markets — the Fed cut its fed funds rate to zero and began pursuing bond purchases, or QE, to achieve its goals.


For the full article: GRADING THE FED’S QE PROGRAM: WEEK 2