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Kass: Get Ready for the Fall

I not only view the impact of easing as waning in influence but also believe that the problem with this parsing is that history shows (QE1 and QE2) that the aforementioned positive impact is not guaranteed and not founded in fact.

In support of this view, I wanted to briefly examine five quantitative easing myths.

Myth No. 1: Quantitative easing boosts asset prices and has a positive wealth effect. While we agree that QE has, at times, pushed up some asset prices, the problem is that sometimes the wrong assets are being pushed up in price. Our analysis shows that the previous QE programs pushed up all sorts of commodities but actually pushed down the market's valuations (P/E ratios). While there has been a close relationship between QE1 and QE2 to higher stock prices, with more easing now perceived as having less of an impact, we are less certain that QE3 could result in a positive net influence. What we do know is that prior quantitative easings produced declines in real personal income (as gasoline prices and the price of other commodities rose). If QE3 is implemented, we are concerned that the outcome will be even worse than the previous one.

Myth No. 2: Quantitative easing helps housing and buoys economic growth. Since the Great Recession of 2008-2009, there is little evidence of a link between Fed easing and improving economic conditions. Fed easing (and a generational low in mortgage rates) during 2009-2012 failed to arrest the drop in U.S. home prices. Housing's problem was (and is) structural as the shadow inventory of foreclosed, heavily delinquent and unsold homes created an imbalance between supply and demand. In actuality, home prices and mortgage activity plummeted to new lows during QE2. It was only after QE2 ended that home prices and sales activity began to recover as the inventory began to be absorbed. The unclear link between quantitative easing and economic growth is captured by Boenning & Scattergood's Rich Farr, who recently wrote the following:

During QE1, the economy did indeed improve; however, it is impossible to prove whether or not QE had any positive impact. When the economy bottomed in first quarter 2009, stocks were near all-time lows in valuation, oil prices and interest rates had collapsed, and TARP and other fiscal stimuli were in effect. As for QE2, the economy actually slowed. During the September 2010 quarter, real GDP expanded at a 2.8% year-over-year rate. Just one quarter later (and only one month into QE2), the economy slowed to just a 2.4% year-over-year rate. In the first full quarter of QE2 (first quarter 2011), GDP grew at just a 0.1% annualized rate (or just 0.01973% quarter over quarter). The U.S. economy continued to slow on a year-over-year basis until fourth quarter 2011, well after QE2 had ended.

Myth No. 3: Quantitative easing lowers interest rates. Most analysis we have seen of QE suggest that both QE1 and QE2 failed to lower interest rates. Indeed, interest rates rose persistently during quantitative easing.

Myth No. 4: Quantitative easing lowers the unemployment rate. Jobless claims rose during QE2. The problem with the U.S. jobs market is not a function of lack of liquidity or that interest rates are too high. Rather, housing's problem in the past was one of an imbalance between demand and supply and now stems principally from structural unemployment. The factors contributing to continued elevated joblessness -- namely, technological innovation, globalization, reduced mobility (after a 35% drop in home prices), a mismatch between available talent and employer needs and the fact that corporations (facing the costly burden of regulation, health care and taxes) have opted to make temporary employment a more permanent feature of the workplace -- are not going away and are not easily solved.

Myth No. 5: Quantitative easing fails to cause inflationary fears and pressures. The recent drop in inflation occurred only after QE2. Again back to Rich Farr:

W hen QE was enacted in November 2010, headline CPI was just 1.1%. In the months during and shortly after QE2, headline CPI surged to nearly a 4% annual rate! Although inflation has slowed since then, prices have not declined. Rather, prices are merely going up at a slower pace. Thus CPI is still 1.5% higher than it was a year ago, when QE ended. All told, the CPI index currently stands at 4.2% above where it was when QE2 was enacted just 20 months ago (a 2.5% annual rate). These lingering effects can still be witnessed in "core" CPI, which is still up 2.2% year over year. The Fed must recognize that there is actual inflation as well as expected inflation. The market reacts to expectations, and many times may overreact to inflationary monetary policy from the Fed. If the market believes that future inflation will be higher than any benefit from the Fed's attempt at lowering interest rates, then rates will rise, not fall, from Fed actions.

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