(Bloomberg Opinion) -- After Federal Reserve Chair Jerome Powell stressed last week that the bank’s plan to buy Treasury bills was in no way quantitative easing, and several of his colleagues followed his lead, economists and market participants began to debate what QE truly means. It’s an issue that’s hard to resolve analytically, yet the discussion may provide insights into the thinking not only of the Fed but also some other systemically important central banks as they face a deepening conundrum.
Speaking on Oct. 8 to the 61st annual meeting of the National Association for Business Economics, Powell said that the Fed’s policy to buy $60 billion of Treasury bills a month through the second quarter of 2020 “should in no way be confused with the large-scale asset purchase programs that we deployed after the financial crisis,” or what is commonly referred to as QE. Instead the Fed’s purchases are intended to calm the wholesale funding market, commonly referred to as the repo market.
Some in the private sector immediately supported Powell’s characterization of the new policy. After all, it was a response to a highly publicized large and unusual dislocation in the repo market rather than a sudden significant weakening of economic conditions. It focuses on short-term securities and not the longer maturities that dominated QE operations. And it comes with a commitment to continue the other open market operations that the New York Fed has been conducting as needed.
So, as Powell noted in his speech, this is not a monetary policy measure per se. Instead, it’s a “technical” step aimed at fixing a particular problem in the plumbing of the financial system.
Not so fast, others retorted.
The start of extraordinary balance sheet operations just more than 10 years ago — what came to be known as QE1 — was aimed at normalizing dislocated financial markets. Only under the successor QE2 policy did the Fed pivot to using this unconventional measure to pursue broader macroeconomic objectives.
They also point to QE2½, also known as Operation Twist, which sought to influence the yield curve, just like the latest measure will, albeit in the opposite direction. The Fed is seeking to bring down interest rates on bills relative to bonds, understandably so given all the worries in recent months about an inverted yield curve fueling self-fulfilling expectations of recession.
Also supporting their view is that, no matter how technical, this measure could prompt an indirect attempt to influence market risk-taking and the spillover to the broader economy. Taking advantage of the new demand for bills from the Fed, the Treasury could shift more of its issuance there, which, with an unchanged funding schedule, would lower the supply of longer-dated bonds, thereby increasing their price and lowering yields – just like QE2 and later QE3. In sum, it may not be a full-scale QE but it could be thought of as, pick your term, a lite/stealth/mini/shadow variant of it.
So, who’s right, and does it matter?
Both sides have points in their favor — so much so that it is hard to declare a winner. Yet Fed officials will most likely continue to stress that the new measure, to quote Powell in the moderated discussions that followed his speech, “ in no sense is this QE.”
At first glance, it may seem puzzling that Fed officials are going out of their way to deny the QE association. After all, why would they look to negate a potential positive effect on the economy when it appears increasingly vulnerable to weakness from abroad. Two reasons may be playing a role.
First, there is growing recognition of the risks of unconventional monetary policy becoming not only ineffective but, as in the case of the European Central Bank and the Bank of Japan, potentially counter-productive — a set of risks that I detailed if central banks remain “the only game in town” for too long, in my book with that title. They include encouraging excessive risk-taking that could harm future financial stability and undermine economic well-being; promoting inefficient allocations of resources, including support for zombie activities that eat away at the resilience and agility of the economy; encouraging contradictory behavior, such as higher savings to counter low interest income; aggravating wealth inequality and the dispersion of opportunities that comes with that; and undermining the policy credibility that is so crucial to the effectiveness of central banks’ forward guidance.
Second, the Fed may not wish to signal that it’s being influenced by political pressure when it has been on the receiving end of considerable White House attacks for refusing to turn to QE. Moreover quite a few economists have questioned why the Fed continues to signal an intention to reduce interest rates at a time of historically low unemployment and other relatively solid economic indicators.
All these contradictory considerations point to a larger issue that should be of particular concern to people like me who believe that well-functioning and effective central banks are central to the health of an economy. They are increasingly vulnerable to lose-lose propositions, regardless of whether its motivation, communication or intended impact. And there is little they can do to counter this other than hope that others, with better-suited policy tools, will finally step up to their responsibilities.
To contact the author of this story: Mohamed A. El-Erian at email@example.com
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Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. He is president-elect of Queens' College, Cambridge, senior adviser at Gramercy and professor of practice at Wharton. His books include "The Only Game in Town" and "When Markets Collide."
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