Williams Has His Doubts About QE

The Fed’s monetary policy has always depended on incoming economic data. It became even more data dependent when the FOMC first formally tied the federal funds rate to the unemployment rate at the December 2012 meeting of the Fed’s policymaking committee. Today, San Francisco FRB President John Williams said, "[C]learly data that's generated by federal government agencies--obviously labor, but also inflation--are key inputs into our thinking about the economy, about our forecast. Obviously, not having that information makes it a little harder to know what's going on." He said so in a Q&A with reporters after presenting a speech titled, “Will Unconventional Monetary Policy Be the New Normal?”

Williams is a nonvoting member of the FOMC, and won’t get to vote until 2015. In his speech, he acknowledged that the Fed’s so-called “unconventional” monetary policies, particularly QE and forward guidance, have become the convention over the past five years. Interestingly, Williams stated that in theory, QE “would have essentially no effect, positive or negative” in a textbook world of perfectly functioning markets.

In reality, he claimed that it can have a positive effect on the economy. More specifically, he noted that numerous studies suggest that “each $100 billion of asset purchases lowers the yield on 10-year Treasury notes by around 3 to 4 basis points.” As for the impact on the economy, he said that the Fed’s $600 billion QE2 purchases might have lowered the unemployment rate by about ¼ percentage point. Wow, that’s a lot of dough for so little bread!

As for forward guidance, Williams admitted, “[C]learly communicating monetary policy and the associated data dependence is simply hard to do well. …Just as good communication can reduce confusion and enhance the effectiveness of monetary policy, poor communication can do the opposite.” He also acknowledged that tying policy to specific data thresholds is “difficult to get right and comes with the risk of oversimplifying and confusing rather than adding clarity.” Finally, he concluded with the following less-than-reassuring thoughts on QE:

Despite all that we’ve learned, the effects of asset purchases are much less well understood and are much more uncertain and harder to predict than for conventional monetary policy. Indeed, the recent outsize movements in bond rates in response to Fed communications about our current asset purchase program illustrate the difficulty in gauging the effects of asset purchases. Moreover, given our limited experience, we can’t be sure of all their consequences, which may play out over many years.