Monday, June 13, 2011

Contra John Cochrane on QEII

U.Chicago economist John Cochrane recently argued (in a Bloomberg article entitled "Is QE2 a Savior, Inflator, or a Dud?: Business Class") that the Fed is basically impotent, and the evidence for this is that: "QE2 doesn't seem to have lowered any interest rates." For students of Scott Sumner and Milton Friedman, interest rates are known to be quite misleading indicators. Also, interest rates are not the only way to measure the effectiveness of monetary policy. Why not look at inflation expectations themselves? After all, what is monetary policy about if not inflation expectations?

He does mention inflation expectations, but oddly he says: "Expected inflation could explain the sharp rise in long-term yields starting in November. But the rate for 10-year Treasury Inflation Protected Securities, or TIPS, rose in parallel, contradicting that interpretation." Why not look at the TIPS spreads? Look at graph of TIPS spreads above. You can see the 5 and 10-year TIPS spreads rose sharply from August 2010 to late April. Notice also that in that period the S&P rose as well (top graph.) I'm not an expert Fed watcher, but wasn't August around the time Bernanke signaled that he was open to more monetary expansion if needed? Could the decrease seen in both graphs since late April 2011 be partially due to market participants realizing that QEIII would not be coming any time soon?

I'm quite open to correction, but why doesn't Cochrane talk about the most relevant indicators, such as TIPS spreads?

(Sources: TIPS graph made using data from and S&P graph from Google Finance.)


  1. The position of the right-wing re QE2 is inexplicable in intellectual terms. The Milton Friedmans, the John Taylors were big fans of QE for Japan. Taylor even has a 2006 paper on his blog gushing about QE2 in Japan. Gushing!

    I suspect old-fashioned partisanship is at play. No one howled about the cheap dollar in the Bush years, but in fact the dollar declined most steeply from 2002 through 2007.

    At one point, conservatives howled about the CPI overstating inflation. Now, we have the core CPI 12 months running at 1.5 percent, and right-wingers are screaming about inflation.

    Really? If you strip out 1 percent to balance for the CPI overstating inflation, you get a core rate of 0.5 percent for the last 12 months.

    In short, the right-wing detest Obama so much they almost literally cannot see straight, or worse, they cynically are recommending policies they hope will undermine him.

    Where were the calls for fiscal rectitude and monetary discipline in the Bush years?

    Actually, I am not an Obama fan. I just believe the Fed needs be very stimulative now, with the economy sputtering and inflation dead.

  2. PS. I think we are going to do a Japan.

  3. Hi Benjamin,
    Thanks for your comment. As a conservative, I must say it's a bit painful these days watching many on the right discuss macroeconomic policy. To be charitable to conservatives, I should point out that that not many people seem to understand this issue, right or left, economist or non-economist. At leas that's the impression I get from reading Sumner.

    The case of Cochrane is especially sad though, because he's at Friedman's old institution. Maybe the insights of Friedman have been lost as economists have decided that math is more important than economics.

  4. Regarding Japan: I still really understand why they've basically pursued 0% inflation over the last decade and a half or so. One imagines this is due to political constraints, rather than the stupidity of the economists there. But I don't really know.