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Christopher Mahoney
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I spent eight years at Bank of America in New York (1978-86) covering Wall Street, then moved to Moody's Investors Service where I worked for 22 years, covering banks, sovereigns and corporates. I chaired the Credit Policy Committee for four years. I retired in 2007 as vice chairman.
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  • QE Verdict After Five Years: A Failure Of Nerve 0 comments
    Sep 24, 2013 8:52 PM
    It is now five years since the Lehman crash and the commencement of the Fed's bond-buying policy known as QE. Since Lehman, the Fed has bought $2.8T trillion of bonds from banks, quadrupling its balance sheet from $800B to $3.6T. Today's topic is: How successful has QE been in delivering strong money growth, sustained economic growth, full employment, and 2.0-2.5% inflation? Answer: unsuccesful. Today, the Fed has zero credibility when it comes to market confidence in its ability and commitment to fulfill its twin mandates. Here is the current data (percent change from year ago):


    M1: 7.0%

    M2: 6.6%

    M3: 4.5%

    M4: 3.6%

    Core inflation: 1.2%

    Nominal GDP: 3.1%

    Real GDP: 1.6%

    Unemployment rate: 7.3%

    We are looking at an economy that has been stuck in second gear for four years, and employment indices that have yet to return to precrash levels. Five years after Lehman, millions of people are unnecessarily out of work and out of the workforce.

    This is because the Fed has not pursued a consistent policy of monetary expansion since 2008. The trillions that the Fed has supposedly "pumped into the economy" are nowhere to be found; they are sitting on deposit at the Fed as sterile and useless excess reserves. They are not "in the economy" and they have had no impact on money growth, inflation expectations or economic growth.

    In the 1981-82 recession, Volcker grew M2 by double-digits for a year, and got things moving. Greenspan did the same thing during the 2001-02 recession, and again got things moving. Bernanke did the same thing in in 2009 and again 2011, but stopped in mid-2012, allowing money growth to fall to its current anemic levels.

    Five years on, we have persistently high unemployment and very weak growth. Nominal growth at 3.1% is far too low to bring down unemployment, and risks another recession. A deflationary recession at this point in the cycle would be disastrous, and would require heroic policies to reverse.

    Bernanke's half-hearted policies have failed to raise inflation expectations. The fact that expectations remain "anchored" at a low level is a sign of failure, not success. The real funds rate needs to be substantially lower than the current minus 1%. The best way to raise inflation expectations is to explicitly target and deliver 3-4% inflation.

    The Fed's talk of tapering QE was a major policy mistake. Not because QE has worked, but because tapering signals a surrender in terms of the Fed's commitment to fulfilling its mandate. It signals that the FOMC is OK with high unemployment and low inflation, and that that the Fed's mandates are aspirational "goals", which it doesn't really need to achieve.

    The failure of QE necessitates a bolder policy, not a more timid one. Wars are not won by retreat. The Fed needs to decisively change its focus from inputs (buying $X amount of bonds each month) to economic results: money growth, inflation and nominal growth. This will require a program of shock-and awe in order to make a decisive break in inflation expectations and market behavior:

    1. Target 10% money growth, 3-4% inflation, and 6-7% nominal growth.

    2. Stop paying interest on excess reserves in order to encourage banks to put them to use in the economy.

    3. Double the size of QE and make it open-ended until unemployment returns to a normal level, say 5%.

    3. Add to the QE buy-list a trade-weighted basket of foreign government bonds, and physical gold.

    4. Commit to raise the price of gold if M2 proves sticky.

    5. Permanently redefine "price stability" as 3-4% inflation.

    The Fed needs to restore its credibility by meeting its mandates, instead of half-heartedly trying to meet its mandates. There are no points for effort in this exercise. This is a very serious business, given the current level of unemployment and the dismal job prospects for young people.

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