QE2

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Today’s Wall Street Journal includes yet another confused article about U.S. monetary policy.  Let’s briefly review what’s under discussion before dealing with the Journal’s issues.

Fed chairman Ben Bernanke and the FOMC announced a new round of “quantitative easing” on November 3.  Some of us are old enough to remember when QE2 was the abbreviation for a luxury ocean liner (the Queen Elizabeth II, still owned and operated by Cunard).  Today those initials have been co-opted by the Fed to stand for the second round of quantitative easing.

The idea here is simple enough.  Banks are not lending their excess reserves.  In fact, the Fed’s latest H3 report includes the following information:

Excess reserves: $973,504,000,000
Required reserves: $66,749,000,000

So instead of just buying more short-term Treasury securities (and expanding the excess reserve base even more), the Fed has decided to make purchases of longer-term Treasury notes and bonds. In fact, $600 billion in new purchases, at a rate of $75 billion per month for eight months. The Fed has repeatedly stated that their concern is deflation.  They are deliberately trying to create inflation.  Here’s an excerpt from their November 3 press release: “Longer-term inflation expectations have remained stable, but measures of underlying inflation have trended lower in recent quarters.”

So what’s the problem?  Apparently some folks don’t understand the yield curve.  This is straight out of the Wall Street Journal article:

The U.S. yield curve

Yield curves before, during, after

Since August 27, yields on T-notes (maturities between 1 and 10 years) have fallen.  However, T-bond yields have risen.  It seems clear to me that the Fed has pretty much succeeded.  Long-term yields are higher because the Fed has managed to increase inflation expectations.  Note, however, that inflation expectations have only risen beyond the 10 year horizon.  Up to 10 years, yields have fallen, indicating that the market pretty much agrees with the Fed: inflation expectations are lower.  (Of course, it’s possible that adding $600 billion in liquidity to this market has lowered relatively short-term yields simply because of expectations of more liquidity.)

What we don’t need is stuff like this:

“… David Ader, head of government-bond strategy at CRT Capital LLC, said … ‘I think the bulk of the move is a position unwind exacerbated by the timing of the year’ …”  “Position unwind?”  Great.