The Federal Reserve's $600 billion bond-buying spree is over, but its effects will be with us for a long time.
On a political level, the quantitative easing program known as QE2 made the Fed a high-profile target for Tea Party activists. Fed officials prefer to remain above politics, but they may not have that luxury during the next election cycle.
For financial markets, QE2 and its $1.7 trillion predecessor, QE1, have created new worries. Because the bond market has never had such a big buyer, the Fed could roil the markets when it decides to start dumping its holdings. Or maybe the next step will be a QE3; no one knows.
Before the Fed can decide on its next move, it has to assess the two previous ones. That was the goal of a conference at the Federal Reserve Bank of St. Louis that couldn't have been more timely. "We're buying the last bond as we speak," St. Louis Fed President Jim Bullard noted as he opened Thursday's meeting.
Most of the participants, a few dozen economists from inside and outside the Fed, spent the day making careful assessments of QE1, which ended in March of last year, and similar programs in other countries. It's certainly easier to do a definitive study of the past than the present.
Bullard, however, was willing to wade in with a ringing endorsement of QE2. "Anyone who's paying attention to financial markets will agree that this had a huge impact," he said as he clicked through charts showing a rise in interest rates, stock prices and inflation expectations after the Fed launched QE2 last fall.
All of those things — even the inflation — were desirable outcomes. Last summer, both measured inflation and forward-looking indicators were hovering around 1 percent, and the Fed was worried that we might experience deflation, or a falling price level.
Skeptics said at the time — and maintain even now — that the Fed had no more deflation-fighting weapons available after it cut short-term interest rates to zero in 2008.
"QE2 worked in reality," Bullard asserted. "There are a bunch of guys who said it wouldn't work in theory, and they're all wrong."
Most of the presenters at Thursday's conference were not among the QE2 doubters. Their studies found that the Fed's QE1 purchases successfully lowered interest rates, which should stimulate economic activity.
"We see fairly large changes in these rates on days of the significant (QE1) announcements," said Matthew Raskin, an economic analyst at the Federal Reserve Bank of New York.
"An objective analyst would say there does seem to be something here; it does appear to be a useful tool," added James Hamilton, professor of economics at the University of California San Diego.
The problem for the Fed, of course, is that neither QE1 nor QE2 has yet brought about a vigorous economic recovery.
Kevin Hoover, professor of philosophy and economics at Duke University, pointed out that while studies showed a link to interest rates and inflation, they didn't demonstrate an effect on employment or economic growth.
"My overall conclusion is that the jury is still out and that there's some basis for skepticism," Hoover said.
Judging from the political rhetoric of late, he's not alone in that belief. Bullard and other Fed policymakers may be convinced that they have a powerful new tool at their disposal, but they still need to persuade the public that it works.
