An unprecedented monetary experiment came to an end last week. The US Federal Reserve ended the third round of its quantitative easing (QE), or money-printing, programme.
It injected a total of $3.7trn into the US economy by buying government and some private bonds with newly created money. The aim was to bolster lending, both directly through banks and via the reduction in bond yields, or long-term interest rates, from bond purchases.
Moreover, because the money was injected into bond markets, encouraging investors to buy other assets with the cash, rising stock and debt markets would fuel the feel-good factor, further bolstering growth – or so it was hoped.
So did QE help? It’s hard to disentangle its impact from other factors – the US experienced a nasty fiscal squeeze during much of QE, for instance – but it seems fair to conclude that while it probably averted a depression, it hasn’t done much more.
The US recovery has been very weak by past standards and the economy only now seems to be reaching ‘escape velocity’, or a self-sustaining upswing.
In modern economies, money is created by commercial banks writing loans. After a banking crisis, overextended banks resort to shrinking loans to restore their balance sheets to health.
Falling lending can result in deflation and depression. QE helped temper the credit contraction by artificially boosting the money supply to make up for the decline caused by banks.
But this is damage control, not stimulus. Simply plugging a gap in the economy can’t make banks boost their lending much or persuade overextended households and companies to borrow. They have to work their debt off gradually after a financial crisis.
This hangover is a multi-year affair, explaining why overall demand, and hence the overall recovery, has been subdued.
And QE has stored up potential problems for the future. It’s not just that many asset markets look bubbly. Fears that all this money printing could lead to a jump in inflation may yet prove justified.
Inflation depends on how fast money moves around the economy (the velocity of money), as well as on how much there is. As demand recovers to pre-crisis levels, velocity will rise, increasing the danger of inflation. It already seems to be making a comeback in America.