With the second round of quantitative easing (QE2) scheduled to cease at the end of June, and a few voices calling for a third round due to weak economic data, now seems a good time to step back and consider what impacts this monetary policy has had for the U.S. economy.
Quantitative easing is a policy implemented by the Federal Reserve that involves the purchases of securities, U.S. Treasuries in the case of QE2, by the nation’s central bank to increase liquidity. It was enacted because conventional guides of monetary policy, such as the Taylor rule, currently call for loose monetary policy. But with the federal funds rate near zero percent, the usual tools of monetary policy have become ineffective. Thus, quantitative easing provides a method of increasing the money supply by other means.
An April 2011 paper published by economists Jeffrey Fuhrer and Giovanni Olivei of the Federal Reserve Bank of Boston attempts to estimate the effects of the Fed’s purchases of Treasuries on key macroeconomic variables. Drawing on the economics research literature and their own modeling, the authors find the following impacts associated with QE2:
- A reduction of 20 to 30 basis points in the 10-year Treasury yield
- An increase in real GDP of 40 to 120 basis points after one to two years (75 to 80 being likely)
- A reduction of the unemployment rate of 0.3 to 0.4 percentage points after two years, implying an increase of 700,000 jobs
The scale of these impacts seems reasonable, but it is worth noting the time lag involved. The full effect takes two years to work its way through the economy. And one could question whether the traditional channels in the economy are in fact open given challenges for small businesses to obtain lending.
So what does this research suggest about the future? The impacts of QE2 will continue to be felt after the actual purchases of Treasuries end later this month. However, unless the channels by which capital is made available to businesses open, the reductions in interest rates, such as the 10-year Treasury yield, will likely not have the intended economic impact over the long-run.
Moreover, we believe that the end of QE2 will not result in a dramatic increase in interest rates, as some commentators are suggesting. First, since the end date of QE2 is known by everyone, the bond market should be reacting now with this information, sending bond prices down and interest rates up. This is not happening.
Second, given the research cited above, the positive impacts from quantitative easing have considerable lags, as will any effects associated with the end of the program. The Fed will not, for example, sell hundreds of billions of U.S. Treasuries at the end of June. Instead, the central bank will sit on its holdings, allowing a gradual reduction of its balance sheet over time.
The net result for housing is that NAHB continues to forecast minor increases in mortgage interest rates, with a 3o-year fixed mortgage interest rate of 5.25% in the fourth quarter of 2011 and 6% at the end of 2012. But we are not forecasting dramatic increases in interest rates due to the end of QE2, as some commentators seem to be calling for.