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 http://www.stlouisfed.org/ and S&P graph from Google Finance.)