QE3?

Rebecca Wilder has this post:

Within 24 hours, China, the US, and the euro area all reported July PMIs falling toward the feared 50 (below which the manufacturing industry is contracting) – 50.7, 50.9, and 50.4, respectively. The UK PMI fell below 50 to 49.1 in July.
I would posit (and I believe that others have, too, like Edward Hugh) that this is directly related to Fed policy, specifically that of quantitative easing (QE).

The chart above illustrates the stated PMIs alongside the dates of a shift in theFederal Reserve’s QE policy. The shorter bars indicate those dates when the Fed ended QE and announced that it would reinvest maturing proceeds. On the other hand, the full bars illustrate the outset of QE.
Falling PMIs correlate with the end of QE. New QE correlates with a rebound in global PMIs. Given this correlation and the latest GDP release, I expect that talk of QE anew to surface.

The bars on the graph are not quite right so I added a couple more. The first short bar does not indicate the end of QE1 (that´s indicated by the red dotted line) but the hint of QE2 at the Jackson Hole Conference on August 27 2010. The green dotted line is added to indicate the moment (April 27 2011) when the Fed indicated QE2 would end on schedule in June.

There is a “nice” correlation between PMI´s and QE´s, but note that while QE1 had a “strong” impact, the impact (or hint) of QE2 was much more subdued. People learn, so they´ve already guessed that QE is just a means to avoid “deflation’ (or too low inflation) risk and as soon as that risk goes away QE is “switched off”. A QE3 would most likely have at most a negligible impact.

My preferred picture, redrawn below clearly indicates that the QE “strategy” didn´t do anything to get the economy back on track or, for that matter, to “upgrade” employment.

If last summer it was thought that the economy was faltering, this year it´s been much worse. But inflation is a lot higher, so the Fed is unlikely to move. The inflation “paranoia” is all over the FOMC, with few exceptions.

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4 thoughts on “QE3?

  1. Well, I hope you are wrong on this, and that a serious QE3 would work. I see few other options. Milton Friedman said QE would work for Japan, and John Taylor said it did work for Japan (see paper on his website from 2006).
    I think we just have to stick with QE, well into the 5 percent inflation rate or so for several years.
    The problem was that Bernanke-san caved into anti-inflation hysteria.

  2. Benjamin The problem is that the QE “strategy” is tainted! Now we know it´s just a means to keep inflation on “target”. Japan used it in the same way. When inflation returned to zero they stopped their QE. They have to be bolder. SS agrees that the best we could get is a price level target strategy, as suggested by Mankiw in his NYT piece on Sunday. Obviouly we all would prefer NGDP targeting, but that´s off the radar.

  3. This is so frustrating. There are times when we have to “suffer” to get to an end–Volcker’s tight-money policies of the 1980s, for example. Now we are suffering so we can suffer and make things even worse.

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