Thursday, February 3, 2011

Bernanke Acknowledges Risings Yields a Sign of Success

For some time now, I have been making the case that a sign of QE2 success would be rising yields rather than falling yields.  Yes, interest rates may initially fall, but if QE2 is successful in raising expectations of real growth then interest rates should start to increase.  For example, back in December, 2010 I said the following:
If QE2 is successful, then we would expect treasury yields to rise!  A successful QE will first raise inflation expectations.  This alone will put upward pressure on nominal yields.  However, expectations of higher inflation are in effect expectations of higher nominal spending.  And higher expected nominal spending in an economy with sticky prices and excess capacity will lead to increases in expected real economic growth.  The expected real economic growth should in turn increase real yields.  It is that simple.
Here is an updated graph from a more recent post that indicates this is in fact happening:

Given this understanding, it has been frustrating to watch the Fed sell QE2 to the public as working through the lowering of interest rates.  This marketing of QE2 creates the false impression it will only work if yields remain low.  It gives critics of QE2 more ammunition and ultimately undermines the effectiveness of the program. Thus, I was please to see Bernanke say this today in his speech:
A wide range of market indicators supports the view that the Federal Reserve's securities purchases have been effective at easing financial conditions... Yields on 5- to 10-year Treasury securities initially declined markedly as markets priced in prospective Fed purchases; these yields subsequently rose, however, as investors became more optimistic about economic growth and as traders scaled back their expectations of future securities purchases. All of these developments are what one would expect to see when monetary policy becomes more accommodative.
It is about time.


  1. I guess it's all good when you're an academic. Maybe, in addition to the higher yields, the record grain prices and $100+ oil are also things that are signaling a new-found optimism.

    The legitimate object of QE2 was to stabilize (raise from the swamp) housing prices. The real object was to further bail out TBTF banks. Only the latter was accomplished.

  2. my take a few weeks back:

    because it isnt working as it was originally prescribed, the Fed and it's apologists have taken to changing their talking points...quantitative easing was first theorized in bernanke's famous helicopter speech, and the theory was built on in several speeches thereafter, as a method whereby monetary stimulus could be achieved when the Fed funds rate is at or near zero already...what QE was supposed to do is LOWER longer term interest rates...the Fed would buy large amounts of medium term treasuries and thereby lower rates along the entire yield curve; that is not happening, in fact, the yield curve between the 2 year note and the 30 year bond was the steepest on record this now bernanke and other officials are citing rising stock prices as proof that QE2 is working; even Fed research has been leant to this cause, leading some to ask when did the Fed get a mandate to manipulate stock prices...other Fed apologists are saying that although nominal interest rates have risen, "real" interest rates (such as you would compute by allowing for inflation expectations) aren't, and that's all the Fed intended in the first place...the "real" interest rate would apply, for instance, if one is saving for retirement; you'd want to keep the purchasing power of your savings intact; but one cant distinguish between real and nominal interest rates with regards to the purpose of QE, because the small businessman wanting a loan or person in the market to buy a home doesnt; payments on a loan reflect the nominal rate...nor will the banks consider the difference between real and nominal when they reset the trillion dollars worth of Alt 1-A and adjustable ARM mortgages over the next two years...nominal interest rates, which are rising, have real consequences for real people; the only consequence of real interest rates is imaginary...

    hyperlinked here:

  3. Huh? Yields rose because of inflationary expectations due to QE2? How about yields rose because economic indicators (ISM) show the economy is actually improving?