It seems like a lot of commenters are insisting that QE2 is failing because interest rates have risen since the Nov. 3 announcement. Of course most of the interest rate effect was already priced in by Nov. 3. But they are also missing a more important distinction - higher rates can be good news, or more specifically a reflection of good news.
Take yesterday’s big move in the bond markets. Five-year T-note yields jumped 17 basis points, from 1.47% to 1.64%. But the yield on 5-year TIPS only rose by 10 basis points, from -0.22% to -0.12%. Thus 5-year inflation expectations rose 7 basis points, from 1.69% to 1.76%. That’s good news folks.
Now some people might say, “Sumner, you can’t have it both ways. The QE2 proponents have been arguing that the falling rates of September and October showed QE2 was working.” Actually I can have it both ways. In the months before QE2 was announced TIPS yields fell much more sharply than nominal yields and thus 5-year inflation expectations rose from about 1.2% to 1.7%.
Message to QE critics (and proponents): Stop focusing on interest rates. Here’s what Milton Friedman had to say in 1997:
"After the U.S. experience during the Great Depression, and after inflation and rising interest rates in the 1970s and disinflation and falling interest rates in the 1980s, I thought the fallacy of identifying tight money with high interest rates and easy money with low interest rates was dead. Apparently, old fallacies never die."
The stock market understands that message. It brushed off the higher interest rates and rose 2% yesterday. And stocks also rose when rates fell on earlier rumors of QE2.
Then there is the argument that the rising dollar (against the euro) shows QE2 isn’t working. I admit to arguing that the strong dollar was a sign of tight money in the spring of 2010. But I wasn’t basing that argument solely on the movements in the exchange rates, which are always an ambiguous signal. A rising dollar can reflect tighter money here, or easier money in Europe. In the spring it seemed to reflect tight money in the U.S., as other asset prices were confirming that signal. And my initial reaction was that the same was occurring in response to renewed problems in the Eurozone. But a good macroeconomist will never fall in love with an explanation. It seems like the Eurozone troubles may be becoming so severe that the ECB will have to become more accommodating. If there is anything the ECB hates more than easier money, it would be a crisis that ripped the Eurozone apart. Here’s a recent story hinting that ECB easing may be necessary to save the euro:
NEW YORK (AP) — U.S. stock futures are rising, building on gains overseas as the European Central Bank meets to discuss its plans to support the Eurozone.
Investors are hoping that the bank will take additional steps to prevent the European financial crisis from spreading to Spain and Italy.
I’m not saying I have high confidence in this explanation, but rather that one must always remember to look at a wide variety of variables when analyzing a situation. Even the very best macroeconomists can become a little too obsessed with one variable. Milton Friedman with the money supply, Robert Mundell with exchange rates. But where they differ from their followers is that they generally knew when to look beyond that one variable, and which other variables were relevant to the problem at hand.
A commenter named Leo made this interesting observation:
Readers should not (as I’m sure you don’t) confuse Hayekian pragmatism for Misesian logic.
I can’t comment on Mises, but I do consider myself a pragmatist. In any given macroeconomic situation there are at least 10 models and variables that need to be considered. Some people will ignore nine of the 10, and then methodically apply Cartesian logic to the one variable that they consider "the real problem." That’s not my style.
PS. What am I monomaniacally focused on? NGDP expectations?
Update: This article has a bit more info on the ECB:
LONDON (AP) — The European Central Bank stepped up efforts to contain the continent’s government debt crisis, as bank president Jean-Claude Trichet announced it would prolong measures to provide ready cash to banks and steady the financial system.
Markets were initially disappointed Thursday when Trichet did not say the bank would go even further and increase its purchases of government bonds. The euro sagged almost a cent during his news conference.
But it quickly bounced back, trading higher on the day on market chatter that the bank might in fact be quietly buying bonds of financially troubled Eurozone countries - despite Trichet’s reticence on the issue.