5th November 2010

F&C: Why QE may not be successful in helping the US economy

Following the Federal Reserve Open Market Committee (FOMC) meeting this week it was announced that another round of quantitative easing (QE) would be implemented. This was fully expected and has mostly been discounted over the last 2 months as Ben Bernanke, the Fed Governor, as well as some of his colleagues, have alluded to its likelihood in various public pronouncements.

The aim of this note is to consider if the Fed is pursuing the right strategy given where we are in the economic cycle. The first round of QE in early 2009 has been credited with preventing a more severe recession, or even a second Great Depression, although it has failed in creating a sustainable recovery or in materially reducing the level of unemployment that is just under 10%. There is still a lot of scepticism regarding the efficacy of QE, even within the Fed itself, and the quote in the title comes from one of its critics, the well regarded financial commentator Edward Chancellor, who believes the short-term gains will be more than offset by the long-term damage to the economy, a view I concur with.

The read-across to the UK is highly relevant; the Bank of England also implemented QE in an effort to regenerate the economy and there has been much recent speculation that there will be a second tranche before the year end. I think this is unlikely because, unlike the US, the unemployment rate is much lower (at around 6%) and there are tentative signs that the economy is still in recovery mode whereas the US economy has clearly stalled in recent months. The UK has also recently announced the details of the austerity measures, mainly focused on cuts in public spending, and will want to assess its economic effects before announcing another round of monetary stimulus.

Therefore, this note will focus on the US experience but the analysis on the efficacy of QE is obviously relevant to the UK and other countries.

What the Fed has announced with QE2

The Federal Reserve, as widely predicted, announced on 3 November that it would start a second round of QE. The vote was not unanimous with one member, Federal President Koenig of Kansas City, voting against to give an overall majority of 9-1. The amount of stimulus was slightly more than expected at $600bn but it is to be spread over a period of several months to the end of June next year so the average purchase of assets will be about $75bn per month. The Fed also stated that its purchases would be concentrated in the 2 ½ to 10 year duration range of Treasury bonds with an average maturity of 5 to 6 years. This came as a surprise to a market that had been expecting it to be more evenly spread over the duration curve. The purchases will be of Treasury bonds in contrast to the last round of QE when mortgage-backed securities were bought; the breakdown of the Fed's balance sheet is shown below as we are about to embark on QE2:

More from Ted Scott, F&C investments

Investments