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The Political Economy of QE and the Fed: Who Gained, Who Lost and Why Did it End?
Abstract:
The Federal Reserve's “quantitative easing” (QE) policy ended in the fall of 2014, even though economic growth in the US was still sluggish, wage growth was stagnant and inflation was still far below the Federal Reserve's target of 2%. In this paper we seek some clues to help explain the Fed's decision by studying the political economy of the QE policy. In particular, we study which business sectors were expected to gain and which ones were expected to lose from the three rounds of QE, indicating, perhaps, the political pressures the business community might have brought to bear on Federal Reserve decisions at that time. This paper is a follow up to Montecino and Epstein (2014) in which we studied the impact of QE I on the large banks that had been counter parties to the Federal Reserve's Large Scale Asset Purchase Program and on other banks that had significant amounts of mortgage backed securities (MBS) on their balance sheets. We showed that these banks' profits were increased by QE1 compared to other banks that did not have a large amount of MBS. These positive effects were especially large for large banks. In the current paper, we extend the analysis to encompass all three rounds of QE, and we study the impacts of these rounds on the expected profitability of all sectors of US business. Here we undertake an “event study” to assess whether there were “cumulative abnormal returns" around the windows of the announcements of the rounds of QE. We find that in QE1, investors’ expectations were quite dispersed but that, as in our previous study, large financial firms (among others) were expected to benefit from QE1, as were several other key business sectors, including energy, construction and autos. With QE2, investor expectations were less dispersed, and most firms were expected to benefit, as judged by abnormal returns. Importantly, during the QE2 round, the mean expected benefits for all firms were reduced relative to QE1. By QE3, only a few sectors, including some subsectors of finance, especially large banks, were expected to benefit, while now a non-trivial set of sectors were expected by investors to be harmed by QE3. Moreover, the mean expected benefit for all firms was quite small, compared with the previous two rounds. These vanishing expected benefits accompanied by more negative impacts suggest that “QE fatigue” might have set in for much of US business. We conjecture that this “QE fatigue” along with the expected negative returns experienced by many banks and other firms by the third round, helps to explain the Federal Reserve's decision to end QE in the fall of 2014.
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