Is QE the Future of Monetary Policy?

One thing I’ve mentioned a number of times in recent months is my belief that we could very well enter the next recession in the USA with the Fed still at 0% interest rates.  If I am right then that would be the first time the US economy has ever entered a recession with rates at 0%.  In other words, we’d be entering a brave new world for monetary policy.

Why do I think this?  Well, first of all, the Fed’s balance sheet is going to remain large for a long time because the Fed isn’t going to shrink its balance sheet by selling assets.  So the effects of QE are here to stay.  But more importantly, I think the economy is operating at a muddle through pace for reasons I’ve discussed previously and that means that the Fed will maintain an accommodative interest rate structure for some time.

The interesting thing about this potential world is that it means QE is the new policy tool of choice.  In other words, QE could potentially replace interest rate policy as the primary policy variable.  This means a number of different things:

  • Investors have to come to grips with the potential reality that QE is not a temporary event.  It could very well become a sustained policy process.
  • The Fed’s repo tool and interest on reserves will remain the primary way through which the Fed will control interest rates if and when it decides to.  In other words, the IOER rate is the de facto Fed Funds Rate.
  • Investors must adapt to the varying transmission mechanisms of QE and the different ways this sustained policy can influence the economy over the course of the entire business cycle.

QE is probably here to stay in some form for the foreseeable future.  In fact, it could become THE policy tool of choice in future business cycles….

Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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  1. Sadly I think you are right. Unfortunately with continued QE there will probably not be any long term reform of policies that do not encourage work. Our once cherished land of the free and home of the brave looks more and more like the land of government intervention and home of the entitled every day.

  2. Until we somehow correct the current off-the-charts concentrations of income and wealth, this unhealthy metabolic syndrome will continue.

    • There is only one way to redress the imbalances of wealth. Let the banks fail next time, and make the depositors whole with printed money only up to the legal limit of 250K per person per bank. Let everything above that level be lost forever.

  3. QE THE policy choice. Huh? Sounds an awful lot like Japan to me. What was that about “the USA being Japan on fast-forward”? More likely, we are Japan x 10.

  4. The Fed thinks the impact of QE will be lasting as it argues that the impact arises from the stock of bonds held by the Fed rather than the flow. I suspect they are wrong i.e as the Fed tapers to nil, despite the large stock of assets on the Fed balance sheet, bond yields will rise. The TICS data is completely misleading i.e some commentators became all excited by Treasury bond holdings rising in Belgium and falling from Asian countries but this just arises from the increased use of Euroclear. Nevertheless, I suspect (all forecasts should be made with humility especially if you have read the Fed minutes from 2008!) that foreign purchases of Treasury bonds will decline as QE taper proceeds and fear of higher interest rates rise. The only way that bond yields will not rise with tapering is if the economy slumps, inflation falls and yet tapering continues as the Fed internally starts to admit that QE has become in economic terms ineffective and its major effect is only on asset prices. This would be a particularly grim outcome but more likely is continued slow recovery with rising bond yields.

  5. Sorry, it took me awhile to understand the implication of this. And I wonder if you get this or not. But the future may be NOW.

    If monetary policy tool available for the fed is QE from now on, current taper may be de facto tightening.

    I’d be interested in what you think.