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Do Treasury Yields Prove QE Had No Effect?
http://mises.ca/posts/blog/do-treasury-yields-prove-qe-had-no-effect/
Bob Murphy (15 December 2014)
Now that the third round of quantitative easing (“QE3″) has officially ended, proponents of looser money are gleefully pointing to low U.S. Treasury yields as (apparent) proof that the Fed never had anything to do with low interest rates. Ironically, these very critics themselves have earlier explained why the Fed would affect interest rates–if at all–through the stock of its balance sheet holdings, not through the rate of flow of its purchases. After documenting the issue with respect to Treasury securities, I’ll switch to gold and make it so obvious that even Krugman should see his non sequitur.
Laughing at Non-Evidence
First let me assure the reader I’m not attacking a straw man. On November 28 Krugman gloated:
Scott Sumner, who wants to be known as the guy who blamed the economic crisis on Bernanke’s tight-money policy, also thinks recent Treasury yields proves that the Fed must not have been pushing down rates either, when he writes:
Stocks vs. Flows
What’s really interesting about Krugman and Sumner’s victory laps here is that they themselves think the central bank affects asset prices through stocks, not flows. It’s particularly ironic that Krugman is pointing to the famous Bill Gross miscalculation, because it was during that episode that Krugman wrote the following in an April 2011 blog post:
As far as Sumner, I can’t find a smoking gun discussion like Krugman’s, but I’m pretty sure he subscribes (at least as a default position) to the “standard economics” Tobin model that Krugman outlines above.
Applying the Logic to QE and Treasuries
So as a baseline first stab at the problem, how would Krugman (and Sumner?) think the central bank might affect the yield on bonds? Well, when investors get information about what the Fed is going to buy, they alter their bids accordingly. Indeed, Krugman didn’t think it was absurd that QE might push down long-term bond yields; he said it might “work” when the program first launched.
Now remember that QE3 was itself open-ended; the Fed never gave a specific dollar figure for how many assets they would accumulate. That’s why Bernanke’s “taper talk” in the spring of 2013 was significant; it gave investors more information about the total stock of Treasuries (and mortgage-backed securities) that the Fed would eventually take onto its balance sheet. And that’s presumably a big reason that Treasury yields rose so sharply in the ensuing months.
OK, if you’re with me so far, then would we expect a huge spike in Treasury yields when the flow of Fed purchases ended on the schedule that investors had been preparing for, for many months? No, not in a baseline model of reasonably efficient financial markets. There could be some real world “friction” of course but the way Krugman and Sumner typically take a “first pass” at modeling financial markets–such as when Krugman ridiculed Bill Gross for thinking the end of QE2 would cause rates to spike–you wouldn’t expect the shutoff of the purchases to matter.
Applying the Logic to Gold
In conclusion, let me apply the logic to gold. Suppose the central banks around the world announced, “We have been reading a lot of Mises lately and so during the course of 2015, we are going to smoothly replace all of our bond holdings with gold, while maintaining the total market value of our balance sheets. Then we will stop our net purchases of gold in December 2015, and maintain our balance sheet’s market value from that point forward, adjusting our holdings of gold accordingly.”
Would it be reasonable to assume that these actions by the central banks would push up the world price of gold, higher than it otherwise would have been? I hope we can agree that would be a reasonable view.
Now the trickier questions: Would the world price of gold respond immediately to the news, or would it spike only when the central banks actually started buying gold on January 2?
Finally, would the world price of gold suddenly crash in December 2015 when the net purchases stopped, and go back to whatever it would have been in the absence of the purchases? Or might it permanently prop up the world price of gold (relative to the counterfactual) if central banks held several trillions of dollars worth of more gold?
"Do Treasury Yields Prove QE Had No Effect?" by Robert P. Murphy is licenses under CC BY-SA 2.5 CA
http://mises.ca/posts/blog/do-treasury-yields-prove-qe-had-no-effect/
Bob Murphy (15 December 2014)
Now that the third round of quantitative easing (“QE3″) has officially ended, proponents of looser money are gleefully pointing to low U.S. Treasury yields as (apparent) proof that the Fed never had anything to do with low interest rates. Ironically, these very critics themselves have earlier explained why the Fed would affect interest rates–if at all–through the stock of its balance sheet holdings, not through the rate of flow of its purchases. After documenting the issue with respect to Treasury securities, I’ll switch to gold and make it so obvious that even Krugman should see his non sequitur.
Laughing at Non-Evidence
First let me assure the reader I’m not attacking a straw man. On November 28 Krugman gloated:
For years those of us pointing to low interest rates as evidence that fiscal scolds were all wrong met, over and over again, one stock answer: those low rates were meaningless, because the Fed was buying up government bonds and keeping rates artificially low. There was a big logical problem with that story: How can the Fed do that without causing inflation? There was also the fact that rates failed to spike when the Fed temporarily ended QE in 2011 — one big thing I got right and Bill Gross got wrong. But the story line has persisted nonetheless.
So the Fed ended QE last month. And today long-term rates settled at 2.18 percent, far below historical norms.
Maybe rates weren’t artificially low, after all?
So the Fed ended QE last month. And today long-term rates settled at 2.18 percent, far below historical norms.
Maybe rates weren’t artificially low, after all?
Scott Sumner, who wants to be known as the guy who blamed the economic crisis on Bernanke’s tight-money policy, also thinks recent Treasury yields proves that the Fed must not have been pushing down rates either, when he writes:
PPS. Oh, and where are all the people who said in mid-2013 that Bernanke’s tapering comments caused much higher bond yields, proving that only QE was holding down yields? QE ended many months ago, and rates keep falling lower and lower. The market is financing our still large budget deficits at 2.74% on the 30-year bonds. Is that the “liquidity effect?” Is that “Cantillon effects?” Don’t be silly.
Stocks vs. Flows
What’s really interesting about Krugman and Sumner’s victory laps here is that they themselves think the central bank affects asset prices through stocks, not flows. It’s particularly ironic that Krugman is pointing to the famous Bill Gross miscalculation, because it was during that episode that Krugman wrote the following in an April 2011 blog post:
I’ve been getting questions about what happens when the Fed wraps up QE2 — related especially to Bill Gross’s public view that interest rates will shoot up. This is related to the question of the extent to which QE2 has kept interest rates low. So a quick exposition of my theoretical position, which also happens to be more or less standard economics.
So: I basically think of asset prices in a Tobin-type stock equilibrium framework (pdf). People make portfolio choices, allocating their wealth among bonds, stocks, etc.. Asset prices – including the famous “q” – rise and fall to match these portfolio choices to the actual asset supplies.
On this view, the fact that the Fed is currently buying some large fraction of debt issuance is irrelevant; interest rates are determined by the willingness at the margin of private investors to hold the existing stock of debt, regardless.
…If you believe that it is obvious that rates will spike as soon as QE2 ends, you have to ask why investors aren’t moving out of US debt now in anticipation; you don’t have to believe in efficient markets to believe that totally obvious gains or losses will be anticipated.
On this view asset purchases matter because over time they change the stocks of assets available : by buying long term federal debt, the Fed takes some of that debt off the market, and hence drives up the price of what’s left, reducing interest rates. The flow – the rate of purchases – matters only to the extent that it affects expected returns.
So: I basically think of asset prices in a Tobin-type stock equilibrium framework (pdf). People make portfolio choices, allocating their wealth among bonds, stocks, etc.. Asset prices – including the famous “q” – rise and fall to match these portfolio choices to the actual asset supplies.
On this view, the fact that the Fed is currently buying some large fraction of debt issuance is irrelevant; interest rates are determined by the willingness at the margin of private investors to hold the existing stock of debt, regardless.
…If you believe that it is obvious that rates will spike as soon as QE2 ends, you have to ask why investors aren’t moving out of US debt now in anticipation; you don’t have to believe in efficient markets to believe that totally obvious gains or losses will be anticipated.
On this view asset purchases matter because over time they change the stocks of assets available : by buying long term federal debt, the Fed takes some of that debt off the market, and hence drives up the price of what’s left, reducing interest rates. The flow – the rate of purchases – matters only to the extent that it affects expected returns.
As far as Sumner, I can’t find a smoking gun discussion like Krugman’s, but I’m pretty sure he subscribes (at least as a default position) to the “standard economics” Tobin model that Krugman outlines above.
Applying the Logic to QE and Treasuries
So as a baseline first stab at the problem, how would Krugman (and Sumner?) think the central bank might affect the yield on bonds? Well, when investors get information about what the Fed is going to buy, they alter their bids accordingly. Indeed, Krugman didn’t think it was absurd that QE might push down long-term bond yields; he said it might “work” when the program first launched.
Now remember that QE3 was itself open-ended; the Fed never gave a specific dollar figure for how many assets they would accumulate. That’s why Bernanke’s “taper talk” in the spring of 2013 was significant; it gave investors more information about the total stock of Treasuries (and mortgage-backed securities) that the Fed would eventually take onto its balance sheet. And that’s presumably a big reason that Treasury yields rose so sharply in the ensuing months.
OK, if you’re with me so far, then would we expect a huge spike in Treasury yields when the flow of Fed purchases ended on the schedule that investors had been preparing for, for many months? No, not in a baseline model of reasonably efficient financial markets. There could be some real world “friction” of course but the way Krugman and Sumner typically take a “first pass” at modeling financial markets–such as when Krugman ridiculed Bill Gross for thinking the end of QE2 would cause rates to spike–you wouldn’t expect the shutoff of the purchases to matter.
Applying the Logic to Gold
In conclusion, let me apply the logic to gold. Suppose the central banks around the world announced, “We have been reading a lot of Mises lately and so during the course of 2015, we are going to smoothly replace all of our bond holdings with gold, while maintaining the total market value of our balance sheets. Then we will stop our net purchases of gold in December 2015, and maintain our balance sheet’s market value from that point forward, adjusting our holdings of gold accordingly.”
Would it be reasonable to assume that these actions by the central banks would push up the world price of gold, higher than it otherwise would have been? I hope we can agree that would be a reasonable view.
Now the trickier questions: Would the world price of gold respond immediately to the news, or would it spike only when the central banks actually started buying gold on January 2?
Finally, would the world price of gold suddenly crash in December 2015 when the net purchases stopped, and go back to whatever it would have been in the absence of the purchases? Or might it permanently prop up the world price of gold (relative to the counterfactual) if central banks held several trillions of dollars worth of more gold?
"Do Treasury Yields Prove QE Had No Effect?" by Robert P. Murphy is licenses under CC BY-SA 2.5 CA
