Fixed Income  

Tapering effect

The role of quantitative easing has evolved. In 2008 QE was introduced to avert a solvency crisis, while present-day QE is more about stimulating activity.

The fact is that the purchase of assets in the QE programme undertaken by the G4 central banks – the Bank of England, Bank of Japan, Federal Reserve and European Central Bank – has caused their asset holdings to jump from 8 per cent to 15 per cent since 2013, see Chart 1.

However it is evident that QE has had a limited impact on the real economy as job creation and gross domestic product (Chart 2) struggled to accelerate. This suggests that in essence wealth effects have been the main impact on the real economy which has led to increased income inequality in the economy since 2008.

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In June Ben Bernanke, chairman of the Fed, said economic and job market improvement could lead to a gradual tapering down of the bond purchases later this year. He then stated it was Fed policy to enact tapering later in the year.

In response to these comments 10-year US Treasury bond yields rose to a high of 3 per cent in September 2013. However the Fed then surprised everyone by not tapering in September, with suggestions that the pending government shutdown was a major factor in the decision. Subsequent quotes from Fed members were illuminating regarding their view of the impact of QE on the economy. Here are some examples:

Narayana Kocherlakota: “Reducing the flow of purchases in the near term would be a drag on the already slow rate of progress of the economy toward the committee’s goals.”

Eric Rosengren: “I think one of the considerations we have to have is how sustainable the improvement in labour markets is. And that partly depends on how fast our economy’s growing. … We need to see growth much closer to 3 per cent than 2 per cent.”

Dennis Lockhart: “We are far from our mandated statutory goals. The economy remains weak.”

James Bullard: “I would like to see inflation coming back toward target before we make a decision to taper.

Charles Plosser: “We missed an excellent opportunity to begin this tapering process in September. This illustrates just how difficult it is going to be to wean ourselves off the extraordinary process of increasing accommodation we have embarked upon and begin to normalise monetary policy in a timely manner.”

The battle between the doves and the hawks is clear. It was seen as a missed opportunity for the hawks who had spent much time in preparing the markets for tapering. They would argue that QE was part of the problem, crowding out private investment by preventing the uncompetitive companies from facing up to their inefficiencies.

Meanwhile the doves suggested that without QE there would be reduced activity in the economy, and that at present the economy was still very weak on unemployment and output readings. They also argue that without inflation pressures there was little to fear by keeping the proverbial printing presses going. They also suggested that the efficacy of QE was failing with the surprise factor being eroded with each subsequent QE programme.