'Which Flavor of QE?'

David Altig:

Which Flavor of QE?: Yesterday's report on consumer price inflation from the U.S. Bureau of Labor Statistics moved the needle a bit on inflation trends—but just a bit. Meanwhile, the European Central Bank appears to be locked and loaded to blast away at its own (low) inflation concerns. From the Wall Street Journal:

The European Central Bank is ready to loosen monetary policy further to prevent the euro zone from succumbing to an extended period of low inflation, its vice president said on Thursday.

"We are determined to act swiftly if required and don't rule out further monetary policy easing," ECB Vice President Vitor Constancio said in a speech in Berlin.

One of the favorite further measures is apparently charging financial institutions for funds deposited with the central bank:

On Wednesday, the ECB's top economist, Peter Praet, in an interview with German newspaper Die Zeit, said the central bank is preparing a number of measures to counter low inflation. He mentioned a negative rate on deposits as a possible option in combination with other measures.

I don't presume to know enough about financial institutions in Europe to weigh in on the likely effectiveness of such an approach. I do know that we have found reasons to believe that there are limits to such a tool in the U.S. context, as the New York Fed's Ken Garbade and Jamie McAndrews pointed out a couple of years back.

In part, the desire to think about an option such as negative interest rates on deposits appears to be driven by considerable skepticism about deploying more quantitative easing, or QE.

A drawback, in my view, of general discussions about the wisdom and effectiveness of large-scale asset purchase programs is that these policies come in many flavors. My belief, in fact, is that the Fed versions of QE1, QE2, and QE3 can be thought of as three quite different programs, useful to address three quite distinct challenges. You can flip through the slide deck of a presentation I gave last week at a conference sponsored by the Global Interdependence Center, but here is the essence of my argument:

• QE1, as emphasized by former Fed Chair Ben Bernanke, was first and foremost credit policy. It was implemented when credit markets were still in a state of relative disarray and, arguably, segmented to some significant degree. Unlike credit policy, the focus of traditional or pure QE "is the quantity of bank reserves" (to use the Bernanke language). Although QE1 per se involved asset purchases in excess of $1.7 trillion, the Fed's balance sheet rose by less than $300 billion during the program's span. The reason, of course, is that the open-market purchases associated with QE1 largely just replaced expiring lending from the emergency-based facilities in place through most of 2008. In effect, with QE1 the Fed replaced one type of credit policy with another.
• QE2, in contrast, looks to me like pure, traditional quantitative easing. It was a good old-fashioned Treasury-only asset purchase program, and the monetary base effectively increased in lockstep with the size of the program. Importantly, the salient concern of the moment was a clear deterioration of market-based inflation expectations and—particularly worrisome to us at the Atlanta Fed—rising beliefs that outright deflation might be in the cards. In retrospect, old-fashioned QE appears to have worked to address the old-fashioned problem of influencing inflation expectations. In fact, the turnaround in expectations can be clearly traced to the Bernanke comments at the August 2010 Kansas City Fed Economic Symposium, indicating that the Federal Open Market Committee (FOMC) was ready and willing pull the QE tool out of the kit. That was an early lesson in the power of forward guidance, which brings us to...
• ...QE3. I think it is a bit early to draw conclusions about the ultimate impact of QE3. I think you can contend that the Fed's latest large-scale asset purchase program has not had a large independent effect on interest rates or economic activity while still believing that QE3 has played an important role in supporting the economic recovery. These two, seemingly contradictory, opinions echo an argument suggested by Mike Woodford at the Kansas City Fed's Jackson Hole conference in 2012: QE3 was important as a signaling device in early stages of the deployment of the FOMC's primary tool, forward guidance regarding the period of exceptionally low interest rates. I would in fact argue that the winding down of QE3 makes all the more sense when seen through the lens of a forward guidance tool that has matured to the point of no longer requiring the credibility "booster shot" of words put to action via QE.

All of this is to argue that QE, as practiced, is not a single policy, effective in all variants in all circumstances, which means that the U.S. experience of the past might not apply to another time, let alone another place. But as I review the record of the past seven years, I see evidence that pure QE worked pretty well precisely when the central concern was managing inflation expectations (and, hence, I would say, inflation itself).