Sometime in the spring of 2009, when the state of the national economy was still murky and uncertain, Tom Clougherty decided it was time for a vacation.
It had been a tough couple of years for Clougherty’s chosen field. At the time he was vice president and economic advisor for the Federal Reserve Bank of St. Louis, and the economic weather, so to speak, had been rainy and cloudy for far too long.
So why not a vacation to Hawaii? It would give him a chance to unwind, to cut off all connection with the constant stream of financial data that had been such a headache since the start of the Great Recession.
He did not know it yet, but his return from that vacation would mark the beginning of a whole new headache entirely.
That March, in an effort to combat the Great Recession, the Federal Reserve embarked on an unprecedented program of quantitative easing, which involved the large-scale purchase of financial assets using freshly created money. As Clougherty explained in a piece published with the Cato Institute late last year, the idea for quantitative easing was to lower interest rates, encourage spending and investment and thereby boost growth and jobs.
But this came at a cost: namely a price tag of about $1.75 trillion in money created out of thin air, used to purchase treasuries and toxic mortgage backed securities, those very same securities that had destroyed the housing market in the first place.
Source: Wall Street Journal
Here’s what troubled Clougherty the most about this new program of quantitative easing: He was positive it wasn’t needed.
“When I came back from that vacation, I told my colleague that I thought the recession was just about over,” Clougherty said at a panel discussion with the Cato Institute last week. “My colleague asked me, ‘What have you been drinking on your vacation?’”
To say the recession was nearing its end in Spring 2009 was to go against the conventional wisdom of the time.
Just when Clougherty was returning from his vacation, then-president of the San Francisco Fed bank Janet Yellen (now Chair of the Federal Reserve Board) said, “We’re in the midst of a very severe recession. It’s unlikely to end anytime soon.”
But the recession would actually end just three months later. Meanwhile, with the advent of quantitative easing, the balance sheet of the Federal Reserve was on the path toward quadrupling, totaling about $4.5 trillion by 2014.
“There were lots of signs the economy was doing better, however,” Clougherty said.
One such sign came in the form of interest rate spreads. Around the time Lehman Brothers collapsed, those interest rate spreads skyrocketed, which was a major barometer for the rise of the Great Recession. But by 2009, those spreads had already fallen back to where they were before Lehman Brothers’ collapse — and were showing signs of decreasing further — and the economy was already stabilizing, Clougherty argued.
The Federal Reserve began quantitative easing under then-Chairman Ben Bernanke in 2009. | Photo: AP
“So you have to ask: Why did we do this?” Clougherty said. “Why did we feel the need? I was against [quantitative easing] from the very beginning, I thought it was something we really didn’t need to do, and all it would do is create a real problem.”
And problems did arise.
Although the size of the quantitative easing program was troubling from a budgetary standpoint, Clougherty argues that it was actually far too small to have any real positive effect on the financial market overall.
“As large as the Fed’s asset purchases were relative to previous open market operations, they were modest compared to financial markets as a whole,” Clougherty wrote. “It is therefore difficult to believe… [that quantitative easing] had a significant impact.”
One of the major purposes for quantitative easing in the first place, as then-Federal Reserve Chairman Ben Bernanke said, was to signal to markets that monetary policy was going to be “persistently more accommodative” in the long run.
The problem, however, is that quantitative easing was only shown to have created a market perception boost in the short run. This makes sense, as market stakeholders heard the news of quantitative easing and immediately increased short-term investment to capitalize it, but then returned to their baseline investment practices soon after. Because “interest rates are unknowable past a few months,” as Clougherty said, “it is impossible to claim that quantitative easing created long-term positivity with regard to how people viewed the market.”
In other words, the Fed spent more than a trillion dollars on a short-term band-aid. What’s worse, that band-aid wasn’t needed in the first place, because the wound was already well on its way to healing naturally.
The Fed spent more than a trillion dollars on a short-term band-aid. What’s worse, that band-aid wasn’t needed in the first place
One clear result of quantitative easing, however, is an increase in risky investing. Because interest rates were so low after QE’s implementation, investors had a higher incentive to hold onto risky investments in order to generate higher returns for their portfolio. This has further increased the wealth gap, as richer investors, who are able to assume more risk, grow richer from higher returns, while less well-off investors, such as pension holders, have to settle for safe investments with historically low returns.
The rich get richer, the poor get poorer, and now the Fed is left in the uncomfortable position of creating an “exit strategy” to bring things back to where they were before quantitative easing was put in place.
It’s unclear how the markets will react. The Fed has set a troubling precedent here. By assuming the market could not heal on its own, it is shifting the burden of market security on the federal government, rather than on the market itself.
Ultimately, Clougherty said, we won’t know the true implications of quantitative easing — or its legacy — until the next crisis, when the Fed will no doubt continue to distort the market in the desperate hope that it will somehow magically return everything to normal.
Until then, all that’s left of the legacy of quantitative easing is an additional $1.7 trillion in the national debt.
Evan Smith is a Staff Writer for Opportunity Lives. You can follow him on Twitter @Evansmithreport.