When the Federal Reserve nudged up interest rates a quarter percent last December, it was the first time the central bank had taken such an action since 2008, when it began cutting rates in the wake of the economic collapse.
But lowering the federal funds rate—the rate at which member banks lend to one another overnight—isn’t all the Fed did to try to revive the economy.
Starting during the dreadful final quarter of 2008, the central bank purchased $2.1 trillion in longer-term securities, including the notorious mortgage-backed securities blamed by some for the crash.
Those purchases, known as quantitative easing, were designed to inject more cash into banks in hopes of lowering longer-term interest rates (short-term rates were already near zero) and stimulating borrowing and economic activity.
It was a titanic, unprecedented transaction. And the Fed embarked on quantitative easing twice more before ending the practice in October 2014. But it worked, right?
That depends on whom you ask.
Take, for example, the three experts who convened for a panel discussion on quantitative easing at SCU last year. The U.S. and world economies are unquestionably in better shape than during the dark days of late 2008. But these experts gave quantitative easing little credit for the recovery and expressed worries about its long-term consequences.
The panel was headlined by Stanford University economist John Taylor, a frequent advisor to presidents and Congress and the creator of the so-called Taylor Rule, which has informed Fed monetary policy for more than 20 years. The rule provides guidance on how much the Federal Open Market Committee should change interest rates in response to changes in inflation, output, or other economic conditions.
Taylor had no qualm with the Fed force-feeding vast amounts of cash into the economy during the crisis. “The problem,” he said, “is they didn’t take it out.”
Taylor and others believe quantitative easing went on too long and distorted investment markets by flooding them with cash.
The moderator for the panel, Patrick Yam MBA ’75, a finance and technology executive and SCU regent—as well as the founder and former manager of a hedge fund and a former economic analyst for the Fed—noted that quantitative easing increased the U.S. money supply fivefold. Of the current national debt of more than $18 trillion, $4.4 trillion, or slightly more than the U.S. annual gross domestic product, can be attributed to quantitative easing, he said.
In a white paper published in 2010, Yam and his co-author argued that the boost in money supply had not had its intended effect of stimulating business activity. They cited evidence showing that corporations took advantage of the artificially cheap money to issue debentures. They then used the money they’d raised not to build factories or invest in research and development but to buy back shares of their stock. Decreasing the number of shares outstanding merely increased earnings per share, which pushed up their stock price. This was not what the Fed had in mind.
The third speaker at the event, economics historian Alexander Field of the Leavey School of Business, said he was skeptical of how much quantitative easing contributed to the recovery. But he also pointed out that fears of its consequences, such as triggering rampant inflation, had not materialized.
Field, the author of the book Great Leap Forward: 1930s Depression and U.S. Economic Growth, which takes a favorable view of the New Deal, said quantitative easing was the “second-best solution” to stimulating the economy. The best would have been a bigger stimulus package of government spending, à la the New Deal. Republican opposition to such a program made its passage impossible, he said.
Yam, for one, continues to worry about the long-term consequences of the liquidity glut. Earlier this year he noted that while the Fed had ceased quantitative easing, the world’s other four major central banks hadn’t. As for December’s upward nudge to the Federal Funds rate, he said, “I think it’s about two years too late.”
What’s needed to get businesses spending, investing, and hiring, isn’t artificially cheap money, he said, it’s the confidence that comes from market forces working in traditional ways.
It also requires the government to think beyond monetary policy, Yam said. The Treasury Department needs to return to a posture of actively formulating fiscal policies that encourage economic growth, he added. A great way to start, he said, would be to restructure corporate taxes to encourage companies to remain in the United States and repatriate their overseas earnings, which have grown to close to $3 trillion.
When it comes to stimulating economic growth, Yam said, “The Fed isn’t the only game in town.”