Kristin Forbes (Opinion, January 20) is correct to suggest that central banks reduce their balance sheets quickly, but she failed to point out that the massive increase in central banks’ balance sheets was unnecessary and ineffective. Historically, the Federal Reserve implemented monetary policy by buying and selling very short-term Treasuries. It did this in order to minimise the effect of its actions on interest rates and the allocation of credit and hence on the allocation of economic resources.
The Fed broke with this longstanding policy in an attempt to reduce long-term interest rates. It did so in spite of the fact that there was nothing in either economic or finance theory to suggest quantitative easing could produce an economically important reduction in long-term rates. When questioned about how QE would reduce long-term rates at the Fed’s March 2009 meeting, David Reifschneider, a board staffer, responded by saying the staff’s analysis indicated that the new policy “has at least a fighting chance of bringing down the general level of long-term interest rates. And if you can do that, and if that spills over into the stock market, the exchange rate, that sort of thing, then you potentially get a major stimulus to the real economy.”
Forbes indicated that “recent research has improved our understanding of how QE works”. It would have been better if she had explained how QE works and provided evidence that QE produced an economically important reduction in long-term interest rates. The research I have conducted and reviewed suggests QE has done neither.
Dan Thornton
Retired vice-president and Economic Adviser, Federal Reserve Bank of St Louis
Des Peres, MO, US
Letter: QE required better odds than a ‘fighting chance’
Pinoy Variant