POLICY ACHIEVEMENTS OF QE2

Brian Sack recently spoke on the effectiveness of QE2.  His comments on the program are listed below and I think they are relatively fair.  I’ve added some brief comments in the bold sections:

The purpose of the asset purchase program was to help the Federal Reserve achieve the economic objectives of full employment and stable prices that it was given by Congress. I believe that the program delivered what could have been expected from it. In particular, let me highlight its success along two dimensions.

First, the LSAP2 program made broad financial conditions more accommodative. This conclusion can be drawn from the behavior of financial markets from late August 2010 to the program’s implementation date in November 2010—a period during which market participants moved from seeing such a program as a remote possibility to expecting it with near certainty.³ Asset price movements over this period included a decline in real interest rates, a narrowing of risks spreads, an increase in equity prices, and a decline in the dollar—exactly the pattern that one would expect to be generated from additional monetary policy accommodation. These changes likely supported economic growth and the creation of employment relative to what would have been realized in the absence of the program.⁴

Should we entirely ignore the surge in commodity prices and the continuing decline in real estate prices? These represent, by a wide margin, the most important inputs in the consumer balance sheet….

Second, the LSAP2 program appears to have raised inflation expectations from unusually low levels and reduced the threat of deflation. The downside risks to inflation had become quite threatening by last summer. Breakeven inflation rates had moved to levels that were well below those consistent with the FOMC’s mandate, even for forward measures covering periods beginning several years ahead. In addition, the pricing of deflation risk, as computed by looking at Treasury inflation-protected securities with different amounts of accrued inflation, reflecting fairly substantial odds of deflation over the next several years.⁵ Since that time, though, breakeven inflation rates have risen back to levels more consistent with the FOMC’s mandate, and the perceived risk of deflation has diminished notably.

Can we really judge this as a net positive when it’s now clear that higher cost push inflation resulted in an economic crunch?  

One criticism that has been directed at the LSAP2 program is that it was unable to restore vigorous growth to the economy. I think this is a reasonable observation but not a strong criticism. It is true that the support to growth provided by the asset purchases appears to have been countered by other factors that have continued to weigh on growth. However, the LSAP2 program was never described as such a potent policy tool that it could ensure a return to robust growth and rapid progress toward full employment in all circumstances.⁶

More importantly, should we consider the possibility that LSAP2 actually hurt growth as real GDP clearly peaked when the program began?  

Despite its limits, the expansion of the balance sheet was seen by the FOMC as the best policy tool available at the time, given the constraint on traditional monetary policy easing from the zero bound on interest rates. The willingness of the FOMC to use this tool is indicative of a central bank that takes its dual mandate seriously and does what it can to deliver on it. The disappointing pace of recovery that has been realized since then suggests that the additional policy accommodation provided by the LSAP2 program was appropriate.

Has the Federal Reserve ever considered the possibility that it is not currently armed with the tools that can defeat this economic downturn?  Furthermore, is it wise to attempt “the best policy” when even the best policy might be ineffective?  

All in all, it sounds to me like Brian Sack is still trying to convince himself that there is a transmission mechanism through which QE works.  I have yet to be convinced how that works….