>   (email exchange)
>   On Thu, Nov 4, 2010 at 11:26 PM, wrote:
>   Do you have any thoughts on this supposed wealth effect?

There is one but I see it as coming from deficit spending, and probably not QE.

Federal deficits support income and add to net financial assets,
which is the financial equity and income that supports the credit structure.

The question is whether QE net adds to nominal wealth via the equity price channel, via ‘valuation’ due to lower long term risk free rates/higher pe’s.

First, the evidence isn’t clear that QE results in higher equity prices, with Japan as the leading example.

Second, there’s the question of whether the maybe 75 billion of annual income- about 1/2% of gdp removed from the private sector- is a stronger force than the valuation benefits of the lower discount rates.

Third, let me suggest that by doing QE on a quantity basis rather than targeting a rate, the change in rates on a ‘bang for the buck’ basis could be a lot lower than if the rate was directly targeted.

Let me give a possible example. Let’s say the Fed simply targeted the 10 year tsy at 2.25%. They would have a bid at that level and buy all the secs the market didn’t want to buy at that level. They may in fact buy a lot or a very few, and possibly none at all, depending on tsy issuance, investor demand, and market expectations. But let’s say for this example they did that and bought a total of $1 T 10 year notes defending the 2.25% level.

Now let’s say that instead, the FOMC had limited the Fed to buying $900 billion. The question then is how high would 10 year notes trade with that $100 billion free to trade at market levels?

What I’m saying is it could be at much higher yields, as the market expectation component of demand does its thing. The yield would simply be the same as if the Tsy had issued $900 billion fewer 10 year notes.

Note that we went for years with no issuance of 30 year t bonds, and 30 years t bond rates on the outstanding bonds did not fall to 0.

Yes, the curve flattened maybe 50 basis points, and steepened again when issuance resumed, but in the scheme of things it was a factor for the macro economy.

In other words, qe, without a rate target, qe might actually reduce rates very little.

It’s all about how much net govt issuance alters the term structure of rates.

So is there a wealth effect?

Yes, but in both directions- removing income lowers it and valuations help it.

And, recognizing QW when done the way they are doing it probably doesn’t reduce rates all that much, the cost of QE in lost income is more likely to be higher than the valuation gains.

Hope this helps!


Looks like it was buy the rumor and then double up on the news.

Either it all sticks or it all unwinds that much more intensely.

Still looks like the latter to me as the notion that QE doesn’t work sinks in. The mood now is there will be QE 3,4,5 or whatever it takes until it does work.

Like the kid in his car seat who keeps turning his toy steering wheel as much as it takes to turn the car.

9 Responses

  1. Warren and others,

    isn’t this whole wealth effect mythical to begin with? The market is a zero sum game in the short term. Someone either lost or will lose at the expense of the people making money in the last month.

  2. “Let’s say the Fed simply targeted the 10 year tsy at 2.25%. They would have a bid at that level and buy all the secs the market didn’t want to buy at that level. They may in fact buy a lot”

    If they did buy a lot, how about the idea of issuing 1 year bills continuously as a partial offset to the extent desired/warranted, letting the market determine the 1 year price – returning some of the income withdrawn at 10 year point back to the private sector at the 1 year point, while still achieving 10 year rate objective – and one year market pricing would be disciplined down the curve by 10 year Fed pricing.

    1. lol – automatic stabilizer of economy? Issue cash when market demands it, collect cash when demanded.. Invert the yield curve when it gets too hot, crush it when it needs to be.

      I think there are some “monetary effects” from the standard school.

      But I’ve always liked these “goverment issue all market demands at a price” ideas. I even like it for the NGDP futures supported by Sumner.

      I worked on inflation futures design at my last job. This is a potentially rich area of trading and study. It is undertraded, but impacts every person in the U.S.

  3. “qe might actually reduce rates very little.”

    The point is surely that QE shortens the average time to maturity of government debt (assuming that it’s just the central bank buying up government debt for ‘near cash’). I believe from observation that there is a yield curve for govt debt, and that in non-crisis situations countries with shorter average times to maturity pay on average a lower interest rate.

    So this is partly why QE reduces average interest rate paid, which is good in the short term (the UK government is borrowing £200 billion via our QE shuffle at 0.5% interest and has effectively retired £200 billion of longer dated government bonds paying 3%!) but in the medium term it is highly risky.

    I see it like the trade off between having a long term fixed rate mortgage at a higher rate, or a short term variable rate mortgage at a lower initial rate.

    1. except don’t confuse the issuer of the currency for the user of the currency. the issuer sets interest rates for further public purpose, and income effects are part of that.

      and while you say paying less interest is ‘good’ for the govt, I say what matters is the private sector, which in this case is receiving less.

  4. I thought you were massively bullish stocks! 🙂

    This is part of that process – the actual news that drives it higher is secondary to the market action.

    1. Yes, longer term, if Congress doesn’t mess with things like trying to pay for not letting the tax cuts expire, and not, in general, moving proactively (in a Japan like way) to bring down the federal deficit.

      Right now I’m near term worried in that a dollar rally will trigger a correction and even soften earnings some.

      But longer term it’s all still pretty good for stocks, but not so much for people working for a living.

      But with every Congressman way out of paradigm risks remain high.

  5. QE2 and Last Rites for the World’s Reserve Currency
    Dollar in the Dustbin


    Millions of Americans have no idea what Quantitative Easing is or how it will effect them personally. That’s why Wednesday’s announcement that the Fed will purchase another $600 billion in US Treasuries merely reinforced feelings of helplessness and a sense that government spending is out-of-control. Unfortunately, Ben Bernanke’s rambling explanation of QE2 in a Washington Post op-ed on Thursday only added to the confusion.
    This isn’t about jobs at all. It’s about power. It’s about who is going to dictate policy to the rest of the world. Bernanke wants emerging markets to bear the costs of a financial crisis that originated on Wall Street and was nurtured every step of the way by the easy money policies of the Federal Reserve.

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