Justin Wolfers put up a “controversial” post:
So the key is for the Fed to reduce long-term rates.
Recently, the Fed has been doing this by “Quantitative Easing.” It’s a terrible name for a simple solution. Just as the Fed adjusts short-term interest rates by buying and selling overnight government securities, it can adjust long-term interest rates by buying and selling long-term government securities. That’s what QE2 did.
Oh! No, it didn´t. QE1 AND QE2 resulted in higher long term interest rates AND rising stock market indices!
The END of BOTH Qi´s was followed immediately by a fall in BOTH long rates and stock indices.
Justin Wolfers again:
Many market commentators are disappointed that the Fed didn’t announce “QE3”—a renewed round of quantitative easing. But they shouldn’t be. The Fed still chose to reduce long-term interest rates, they just decided to do it with a different tool. They figured that if you can’t reduce short-term interest rates further, you should reduce ‘em for longer. That’s what the Fed was promising, when they said they expect to keep their short-term rate at “exceptionally low levels for the federal funds rate at least through mid-2013.” What does this do? Keeping short-term interest rates lower for longer will also reduce long-term interest rates. And that’s the main game. It has already worked—perhaps even more reliably than following QE2. The interest rate on two-year bonds is down to virtually zero, and the 10-year interest rate is down to 2.2 percent.
So yes, we got lower long-term interest rates. That’s what matters. And it doesn’t really matter how we got there.
Scott Sumner says it´s wrong to reason from a price change, something which Wolfers “confirms” he did in the underlined passage above.
In fact, both long term rates and the stock market were falling BEFORE the FOMC meeting of August 9.
After the meeting, on a daily close basis, they seem to be trying to figure out what comes next (Jackson Hole?). In addition to the “another 2 years of “zero” FF rate”, the statement said:
The Committee discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability. It will continue to assess the economic outlook in light of incoming information and is prepared to employ these tools as appropriate.
Which is very similar to the Jackson Hole 2010 Bernanke speech:
In particular, the Committee is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly.
In 2010 it was about the “outlook deteriorating”. Now it´s about “promoting a stronger economic recovery”. And as we well know, the economy is in worse shape now than it was a year ago!
Instead of QE which is no more than a “switch” that sometimes is turned “on” and then “off”, i.e not a “policy” but a series of ad hoc “actions”, why not take the opportunity to get rid of “interest rate targeting” and adopt, as Scott Sumner, David Beckworth and a growing “cabal” suggest, an NGDP Target, in which case a “switch” will be “on” until the target is reached.