QE3: How long before the Fed’s stimulus helps the real economy? About six months.

September 14, 2012

It didn't take very long for financial markets to go nuts over the Federal Reserve's new quantitative easing program. The S&P 500 and the Dow Jones indices surged to their highest levels since 2007 on Thursday. Among investors, at least, there was much rejoicing in the land.


Excitement in the stock market, but what about everyone else? (Richard Drew/Associated Press)

But what about the rest of us down here in the real economy? According to Joseph Gagnon, a fellow at the Peterson Institute for International Economics, it will most likely take about six months before the Fed's new stimulus program has any noticeable effect on unemployment and growth.

Gagnon bases that estimate on a 2009 study by Jean Boivin, Michael Kiley and Frederic Mishkin, which found that central bank actions tend to start influencing economic growth about six months after they're announced, on average, while their effects dwindle after about two years. Occasionally, central bank actions can take effect more rapidly — in the aftermath of the 1992 financial crisis in Sweden, the Sveriges Riksbank managed to depreciate the currency 20 percent and boost the country's economic fortunes fairly quickly.

But Gagnon says that the Fed's newest quantitative easing program is a lot smaller than what Sweden did back in the 1990s. "This is tinkering at the margins," Gagnon says. "The Fed is pushing the accelerator a bit further, and this is coming on top of other actions, but I don’t expect a sharp boost in growth."

Indeed, the Federal Reserve itself seems to agree. On Thursday, the Federal Open Market Committee released a new set of economic projections (pdf) for the years ahead. Even with the new stimulus program, the U.S. economy is expected to grow a measly 1.8 percent in 2012. Unemployment will still hover around 8.1 percent by the end of the year. Those numbers are actually worse than what the Fed was predicting in June.

Fed officials now expect slightly more growth in 2013, with the economy expanding somewhere between 2.5 to 3 percent. (This is assuming that Congress manages to ease the scheduled tax hikes and spending cuts in the "fiscal cliff," which Ben Bernanke conceded yesterday could throw the economy back into recession.) But that's still only slightly higher than the Fed's June prediction of growth between 2.2 to 2.8 percent. And even with the new stimulus, it will still take years and years before the economy gets back to full employment.

Gagnon expects that the Fed's program to buy up $40 billion per month in mortgage-backed securities will have a modest effect on the housing market, likely only lowering mortgage rates around 0.25 percentage points. Some analysts have argued that banks will be more likely to originate new mortgages now that they can be confident that the low rates will persist for some time. (Up until now, banks have been reluctant to lend, even though they're flush with cash.) But, says Gagnon, "it's not the be-all and end-all. I actually wish the Fed had been even more aggressive."

Economists have also noted that the Federal Reserve's new program will probably influence future expectations about the shape of the U.S. economy. The central bank said Thursday that it will continue its easy money policy until "a considerable time after the economic recovery strengthens." That's a radical shift in policy — the Fed is trying to bolster confidence that it won't withdraw its support at the first hint of a recovery. But the likely impacts of this shift, Gagnon says, are mostly theoretical and harder to measure.

Add it all up, and it's unlikely that QE3 will sway the presidential election this fall. The stock market will rise and economic confidence might go up. But unemployment and economic growth likely won't get an extra lift until early next year. If Bernanke had wanted to assist President Obama's reelection campaign, he should have announced this program six months ago.

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Dylan Matthews · September 14, 2012