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Quantitative Easing: How Well Does This Tool Work?

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Letter Writer:

Daniel Nevins, Wayne, Penn., principal of Nevins Research and author of Economics for Independent Thinkers.

Date Posted:

Dec. 15, 2017

Letter:

Stephen Williamson's QE article takes a jump that warrants a closer look.

He first cites the portfolio balance theory, which relies on banks and broker-dealers replacing bonds sold to the Fed with either new loans or new bonds, thus depressing long-term yields. In other words, the theory presumes that QE offers an addition to, not a replacement for, other financial intermediation.

But Williamson's alternative theory depends on QE replacing other intermediation.

To determine which perspective is more realistic, we can use a natural experiment - measuring changes in credit activities from QE1 to QE-pause to QE2 and so forth. And that analysis shows that credit growth alternated almost perfectly between the Fed, on one hand, and banks and broker-dealers, on the other. During QE periods, banks and broker-dealers mostly chose not to increase net lending. (The full results are at http://nevinsresearch.com/blog/qes-untold-story-a-chart-that-fed-correspondents-should-investigate.)

In other words, our natural experiment backs Williamson's argument that we should evaluate QE as a replacement to other intermediation.



Letter Writer:

Emi Igawa, Nagoya, Japan

Date Posted:

Dec. 15, 2017

Letter:

I agree with you on the point that QE should not be repeatedly used in the future as a monetary policy because (1) purchasing private bonds is too influential to the firms' financial health, which may result in economic biases; and (2) public sentiment can no longer be more optimistic than it was from 2008.

On the other hand, I believe that people's faith in the QE positively worked at least in the past. In the analyses with Japan and Canada, you did not mention exchange rates. However, both Japanese yen and Canadian dollars significantly changed during the past decade. I also studied international economics and learned that Canadian transports with the U.S. remarkably increased after US-Can FTA (1989), and its economy became more reliant on the U.S. economy. Likewise, Japanese trade volumes and its stock prices are reacting in accordance to JPY-USD exchange rates.

Therefore, the fact that Canadian real GDP boosted without QE is explained by 1) its reliance on US economy, and 2) large fluctuations in exchange rates.

By the way, nominal GDP in U.S. dollars shows completely different trends. The growths from 2008 to 2015 are: Canada 0.24 percent, Japan -13.06 percent and U.S. 23.11 percent.