No, QE Is Not Costless

I ran across a couple lame attempts at blaming the U.S. Treasury for not extending the duration of issuance during the pandemic low in yields. This is entirely typical for market commentary — going after fiscal policymakers and ignoring the major culprit, which is the central bank. To the extent that the United States has put itself into an awkward macro stabilisation situation with respect to interest rate expenditures, it is the result of the brain trust at the Federal Reserve.

One could try arguing that if the Treasury lengthened issuance maturities and the Fed buys those bonds back, the Treasury has locked in their funding cost and that is all that matters. The problem is that approach ignores that the Fed is a wholly-owned subsidiary of the Treasury1, and so when the Fed blows itself up on hare-brained levered rates positions, the Fed losses will work its way into the fiscal accounts via reduced dividends. Financial accounting consolidates wholly-owned entities for a reason.

I will accept that there might have been a “market functioning” argument behind the initial wave of purchases. However, once the initial shutdown panic subsided, there was no need for the Fed to keep gorging its balance sheet with assets. At best, these purchases lowered long-term yields by 50 basis points or so — magnifying everyone’s capital losses (private sector as well as the Fed) on the way up. Yay.

Meanwhile, the Fed managed to inflict “fiscal dominance” upon itself, where “fiscal dominance” was the big bugbear of neoliberals. By shortening the duration of the liabilities of the consolidated Federal government, interest payments now have a much greater sensitivity to the policy rate. Unless you want to pretend that the multiplier on interest spending is zero, that is going to counteract the alleged braking effectiveness of rate hikes.

It is completely typical for the Fed to take credit for things that they probably did not do, while studiously avoiding blame for their own policy blunders. They are aided and abetted in this stance by prominent economists who do not want to lose their Jackson Hole invite. About the only people who questioned the balance sheet expansion are the hard money cranks who have been continuously wrong about the inflationary impact of the policy.