Quantitative Easing - The Proof is in the Pudding
By Abshir EssePublished April 5, 2014Last Wednesday, Janet Yellen, Ben Bernanke's successor as the Chairperson of the Federal Reserve, presided over her first policy meeting. At the conclusion of this meeting, one thing was abundantly clear, the end of the Fed's economic stimulus initiative is in sight and rising interest rates are on the horizon. This transition presents a prime opportunity to reflect on the unprecedented quantitative easing program or the purchasing of securities, initiated in November of 2008. When this policy was first initiated, there was considerable opposition criticizing the necessity of this program and illuminating its potential repercussions, such as hyperinflation. Nearly six years have lapsed since the start of this program and a couple of things are clear: the economic stimulus facilitated by the Federal Reserve was absolutely necessary and these actions have proved efficacious in stabilizing the economy.
The main argument against the unprecedented scale of this quantitative easing policy was that it would lead to historic levels of inflation. Nearly six years after the commencement of this program, this inflation is nowhere to be found. In fact, inflation, as measured by the annual change in the price index for personal consumption expenditures, is only at 1.13% (inflationdata.com); still short of the FOMC's target inflation rate of 2%, which is consistent the Federal Reserve's mandate for price stability and maximum employment.
Another reason for the scale of the Fed's economic stimulus is the fact that the Obama Administration's proverbial economic toolbox was locked, because of a recalcitrant congress, unwilling to cooperate with his many attempts to get job bills passed. So, in many ways, congresses reluctance to pass the President's fiscal policy efforts catalyzed the need for the very monetary policy program, which they oppose.
Finally, at the beginning 2009, the stock market lost over 50% of its value, with the Dow Jones Industrial Average (DJIA) hitting it a low of $6,547.05 (wsj.com). Why does the stability of the capital markets matter? In 2012, the financial services industry represented 7.9% of US gross domestic product (GDP) and U.S. asset managers held more the $40 million of assets under management (selectusa.commerce.gov). From equity research analysts to investment bankers to life insurance policy underwriters, the financial services industry is one of the largest employers in this nation, so stabilizing the capital markets was key to preventing further losses in the labor market.
A common argument is that the low interest rate environment resulting from quantitative easing only positively affects Wall Street. These effects may disproportionately affect Wall Street, but their effect on "Main Street" is real, nonetheless. The health of the stock market is crucial to American families whose 401k plans are heavily invested in the stock market, not to mention corporate and public pension funds and the endowments of philanthropic foundations and universities. As I aforementioned, the U.S. equity market lost over 50% of its value in March of 2009. As a result the Fed's economic stimulus, the stock market has recovered remarkably well since its trough in March of 2009 (see chart below); last year, the S&P 500 had a record year, increasing in value by approximately 30%.
The most significant way in which the Fed's quantitative easing program spurred economic growth was its downward pressure on debt servicing costs or cost of financing. At the end of October of 2008, the 30-year fixed mortgage rate average was nearly 6.5%; at the beginning of May of 2013, the 30-year fixed mortgage rate average was 3.35% (research.stlouisfed.org). The low interest rate environment created by quantitative easing allowed countless American families to refinance their mortgages. This effectively increases the discretionary income of families and encourages consumer spending. Families were not the only ones to take advantage of these low interest rates. Overly leveraged (debt-burdened) small businesses and corporations alike were able to refinance their debt, which added stability to their businesses and gave them more money to invest in capital expenditures, such as new factories, to grow of their businesses and in return, grow the economy as a whole. Even municipalities took advantage of the low rates interest rates by refinancing their existing debt and issuing new debt via the municipal bond market to finance things such as infrastructure projects that create jobs. The effect of quantitate easing on debt servicing cost is often overlooked, but it has been essential to normalizing economic growth.
By 2016, it is expected that the federal funds rate will normalize in 2015-2016, depending on how quickly the Fed's benchmarks for full employment and inflation are reached. The Federal Reserve's forward guidance is an integral component of this nation's path to economic recovery. The lesson is: in times of unprecedented economic turmoil, unprecedented measures are often necessary. History will show that the Federal Reserve's massive quantitative easing effort was necessary and quite effective at nursing this nation's economy back to life.