Well, round three of Quantitative Easing is over. The monetary policy in the United States that has dominated the world for the past several years is done.
Dominated the world you ask?
Yes, dominated the world.
All of the funds that the Federal Reserve created to purchase US Treasury securities and mortgage-backed securities did not stay in the United States!
If one traces the flow of funds through the banking system in the H.8 statistical release of the Board of Governors of the Federal Reserve System, there were times when it appeared as if 40 percent to 50 percent of the excess reserves created in the banking system found their way “off-shore” to branches of “foreign-related institutions.”
The Federal Reserve provided liquidity not only to banks in the United States but also to banks in other countries…we believe primarily in Europe.
Furthermore, there are more and more charts being presented everywhere showing how stocks in the United States responded to the three rounds of quantitative easing…showing a clear correlation between rising stock prices and rising excess reserves in the banking system.
How about short-term and longer-term interest rates?
Well, short-term rates, specifically, the effective federal funds rate dropped below 20 basis points (0.20 percent) in December 2009. The rate remained below 0.20 percent, dropping as low as 0.07 percent up until the present time.
There is a real question mark about how important the role of the Federal Reserve was in keeping this rate at such a low level. The question mark arises because it is not altogether clear that there was much demand for this short-term money, so there was no demand for the effective federal funds rate to rise.
This is an important issue and I will discuss it again later in this post.
What about longer-term interest rates?
In December 2009, the yield on the 10-year government note was 3.60 percent. In October 2010, it had dropped to about 2.50 percent. In February 2010, the yield was around 3.60 percent again before dropping below 2.00 percent in September 2011…and then falling to about 1.50 percent in July 2012.
The 10-year yield then jumped up to 2.90 percent in December 2013 before falling off to its current level of approximately 2.50 percent.
So, longer-term interest rates have fallen but they have not followed a continuous trend since December 2009.
Were the variations in the rate congruent with the three periods of the Fed’s quantitative easing. The answer to this is no! The variations in the longer-term interest rate were tied more closely with the crises that took place in Europe. When Europe had a financial crisis, it seems as if a lot of “risk averse” money leaving Europe found its way into the United States and ended up having a major impact of longer-term US interest rates. Both major swings in longer-term interest rates since December 2009 were more closely associated with flows leaving Europe and flowing into “safe haven” assets in the United States.
Over the whole period were these longer-term interest rates, on average, lower because of the Fed’s actions than they would have been otherwise?
Some economists say that they can show that the Federal Reserve did produce lower longer-term interest rates because of quantitative easing. I must say that I am not convinced by these studies and tend to argue that the Fed, over time, has little or no effect on longer-term interest rates. The behavior of these longer-term interest rates since December 2009 was more the result of international flows of funds, in my mind, than they were a result of Federal Reserve ease.
Did this easy money help the economy?
Over the five full years of the current economic recovery…from July 2009 through June 2014, the compounded annual rate of growth of the United Stats economy was 2.2 percent. At no time, did the annual year-over-year, growth rate touch 4.0 percent.
As things stand right now, this is not a very good economic performance…and that is an understatement.
I would argue that quantitative easing did help to keep the economy from dropping off into more severe recession…or, even a depression. But, I would also argue that the actions of the Federal Reserve did little to achieve a more robust rate of economic growth.
So, the Fed’s actions could be said to have provided downside protection to the economy.
Federal Reserve policy, I would argue, also prevented a catastrophe in commercial banking. And, this was one of Ben Bernanke’s primary goals. Even with such a sever financial crisis, there were no bank holidays and although there were bank closings, the regulators were able to close insolvent banks in a calm and orderly fashion so that no panic ever set in.
So, the Fed’s actions kept the banking system going.
Both of these achievements are very commendable outcomes.
Now, what about the future? No more quantitative easing. Alright…
What about interest rates? Well, the Fed has stated that short-term interest rates will remain near zero for a “considerable time.”
Some analysts are now saying that short-term interest rates could remain near zero into 2016!
In trying to understand this and possible Federal Reserve actions, there is a dilemma. Tell me what will cause short-term interest rates to rise. If the economic growth remains as low as it has been for the first five years of this economic recovery, then there will continue to be little demand for loans, and hence, no market pressure for interest rates to rise.
But, if economic growth remains low, the Federal Reserve will not want to raise short-term interest rates because that might even further inhibit faster future economic growth. So as long as economic growth remains low then the Federal Reserve will not cause short-term interest rates to rise.
Hence, short-term interest rates will only begin to rise again when economic growth becomes strong enough to put upward pressure on the market causing the rates to rise. This is uncharted territory requiring close watching!
About John Mason John has been the President and CEO of two publicly traded financial institutions and an Executive Vice President and CFO of a third. He has also spent time as an economist in the Federal Reserve System and worked for a cabinet secretary in Washington, D. C. In addition John taught in the Finance Department at the Wharton School of the University of Pennsylvania for ten years. He now currently has a column on the blog Seeking Alpha and is ranked number 3 in terms of readers on the economy. From this column, two books have been published this past year from earlier blog posts. John is active in the shadow banking world, the venture capital space, and in angel investing. Other than that John works with start ups and early stage organizations, for profit and not-for-profit.