Obsession

September 18, 2014

Its nearly official. The Federal Reserve confirmed yesterday that if all goes according to plan, it will finally stop its policy of creating new money from thin air and using it to buy financial assets.

This practice, better known as quantitative easing, is what central banks do when interest rates are stuck near zero and cant be lowered any more. (Like lowering interest rates, QE represents an easing of financial assets, by boosting the quantity of money, or at least of the money-like substance that the Fed actually creates: bank reserves.)

During the crisis, the interest rate the Fed traditionally uses to make financial conditions tighter or looser hit zero pretty quick.

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So the Fed then switched to quantitative easing to try to support the economy. It was QEit came in a number of stages that ballooned the Feds balance sheet in recent years. At last glance, the Feds assets totaled about $4.42 trillion.

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Now, if all that money was just sitting parked at the Fed, it raises a question: Did QE actually do anything?

Well, to be honest, nobody really knows for sure. Economics is a social science, not a hard science. Its not like were running these experiments under ideal conditions and clinical isolation.

Critics might point to statistics such as the velocity of money, which show that the rate at which money passes through the economy has continually declined in recent years. They argue that this shows the Feds money-creation policies have been ineffectual.

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But there clearly have been impacts. QE is widely creditedor blamedfor boosting the prices of assets such as stocks. While the US economy has had a tough run, the US stock market has had a fabulous one over the last few years, helping repair the balance sheets of American households. (Its true that the stock market surge has disproportionately helped the richest Americans. But it has also likely helped overall consumer sentiment, at least a bit.)

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And while its impossible to prove causation, a sharp curtailment of business lending activity began to turn not long after the Federal Reserve began pumping vast quantities of cash into the system with QE.

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Another thing to consider is that while its unclear how much the Feds QE policy helped, its equally unclear how much worse things might have been in the US without it. But there are some hints. In the US, the Feds QE was part of a fast, aggressive approach to counteracting the pernicious aftershocks of a major crisis.

In Europe, the central bank didnt embark as aggressively on the same kind of balance-sheet-based easing program:

And the outcomes in the US have been much better, with the unemployment rate falling sharply, in comparison to the euro zone.