"'Progress report on QE2"

Jim Hamilton evaluates QE2:

Progress report on QE2, by Jim Hamilton: We're now 3 months into the Fed's new asset purchase program that has been popularly described as a second round of quantitative easing, or QE2. ...

The essence of QE2 is that the Fed buys some longer-term Treasury debt and pays for it by creating reserves on which the Fed pays an overnight interest rate. In my view, in the current environment, interest-bearing reserves are for all practical purposes the same kind of security as a very short-term Treasury bill. The net effect of such a Fed operation is to lower the average maturity of the combined outstanding debt of the Federal Reserve and Treasury. One view of how such an operation might affect the economy is that a big enough drop in the net supply of long-term debt might result in a decline in long-term yields. ...

I noted in December that QE2 as actually implemented ... has primarily been buying debt of intermediate maturity (2-1/2 to 10 years) rather than the longest term debt outstanding. Second, the Fed spread these purchases out over a period of 8 months, during which time we could anticipate significant changes in the composition of debt issued by the Treasury which could potentially offset any effects of QE2. ...

However, since the start of 2008, ... the Treasury has been issuing more long-term debt faster than the Fed has been buying it ...

Our conclusion is that if QE2 made a positive contribution to the improving economic indicators since the program began, it could not have been through the mechanism of shortening the maturity of publicly-held Treasury debt.

This does not rule out the possibility that QE2 had an effect through some other channels. Another possible mechanism is that, by announcing QE2, the Fed successfully communicated that it had a higher inflation target than some observers had assumed, and successfully communicated that the Fed had both the tools and the will to prevent outright deflation. It appears to be quite an accurate characterization that QE2 did have an effect on many people's expectations. Indeed, some observers had quite a passionate response that I find hard to reconcile with the fundamentally modest nature of what the Fed has been doing. Using the tool of QE2 as a device for helping to manage expectations is in fact the main argument I can see for having the Fed rather than the Treasury be the agent responsible for announcing and carrying out the plan. Even so, I doubt that it can make much sense for the Treasury to pull so hard in one direction that it completely undoes any real effects of QE2.

But whether it makes sense or not, that's what's been happening so far.