BUTTONWOOD continues his scepticism of the value of the Federal Reserve’s new asset purchases in a post citing a study by David Ranson of Wainwright Economics. Mr Ranson has conducted a basic analysis tracking growth and inflation between 1950 and 2007, relative to change in the monetary base. He finds that growth is higher in years with slower monetary base growth, and Buttonwood concludes:
QE just expands claims on wealth, not wealth itself, and thus does not really help the economy.
As you might expect, I don’t find this particularly persuasive. For one thing, the monetary base doesn’t move off trend that much, and when it does its typically due to countercyclical Fed action:
The base drops as the Fed tries to cool an overheating economy, rises as the Fed tries to perk up a lagging economy, and soars when crisis strikes. It should be obvious that growth is generally the response to, rather than the cause, of an expectation of slowing growth.
The other significant point to make is that the changes in the monetary base are not ends in themselves, so far as the Fed is concerned. The Fed’s goals concern employment and inflation. And its actions influence those variables by their relation to public expectations. If the Fed observes that changes in the monetary base appear to be consistent with falling inflation expectations (which act as a proxy for growth expectations), then it will adjust the pace at which the the base is changing (and this could mean a slower decline just as much as a faster rise). That, in turn, will feed through to expectations.
That’s precisely what the Fed has done, and it has quite clearly worked. Inflation expectations have gone from falling last summer to rising. Growth expectations have risen sharply. And real economic variables are improving across the board. At this point, I think critics can still argue that QE2 could bring with it negative side effects (the most realistic of which, in my view, is the impact on emerging markets). But the case for QE2 impotency looks all but dead