When Ben Bernanke departed as Chairman of the Federal Reserve last year, he was asked if Quantitative Easing really worked. He quipped, “The problem with QE is that it works in practice, but it doesn’t work in theory.”
Quantitative Easing was a strategy of buying bonds to drive down long-term interest rates when the short-term rates are at nearly zero. The current Fed Chief, Janet Yellen, has spoken of tapering off asset purchases. The European Central Bank and the Bank of Japan are considering similar strategies to prop up their economies, according to the Financial Times.
While the report card on Quantitative easing shows approval from economist for QE1 in preventing a catastrophic depression in 2009, the jury is still out on QE2 and QE3, with many noting that the American recovery is far from over.
The Financial Times observes that in theory, such a strategy should have no effect, since the government is trading one kind of government debt, money, for another, treasury bonds. The only way this can work is if investors prefer one kind of debt to another, and Bernanke’s position was they do, in practice. As the American economy normalized somewhat, the Fed’s bond buying was valued as more of a signal of the state of the economy rather than a strategy in and of itself. As a results, stocks often swooned on news the Fed would cease buying bonds, as stockholders feared rates would rise.
Charles Evans, President of the Chicago Fed said, “Yes, we bought (bonds) in large numbers. But I think it provided tremendous confidence to the public that we understood the economy wasn’t performing well, and we were going to do what it took in order to improve the trajectory.”