Assessing QE: Why Counterfactual Thinking Is Important

I recently made the case that many observers are not thinking properly about the Fed’s Quantitative Easing (QE) programs. Using the analogy of George Bailey’s life in the film It’s a Wonderful Life, I argued that the critics who question the efficacy of the QE programs are doing the wrong counterfactual. Today, Barry Ritholtz makes the same point:

One of the analytical errors I seem to constantly come across is what I call the non-result result. It goes something like this: If you do X, and there is no measurable change, X is therefore ineffective.

The problem with this analysis is the lack of a control group, If you are testing a new medication to reduce tumors, you want to see what happened to the group that did not get the tested therapy. Perhaps their tumors grew and metastasized. Hence, no increase in tumor mass or spreading is considered a very positive outcome.

This seems to get loss in the debate over QE. The debate — either ignorantly or disingenuously — makes claims such as “Look how few jobs have been created, and look how high unemployment is.”

Understanding this logic, and lacking a control group, we must employ a counter-factual. The question one should be asking is “How many less jobs would have been created?;  How much higher would unemployment be?”

This idea is nicely summarized by the QE counterfactual produced by Poltiical Calculations. It shows what would have happened to nominal GDP had there been no QE3. It is not a pretty sight:


I too ran a QE counterfactual in my George Bailey post. There I considered what would have happened to employment, the stock market, PCE core inflation, and the repo interest rate conditional on (1) the Fed not increasing its share of marketable treasuries starting in late 2010 and (2) the Eurozone crisis, China slowdown, and fiscal policy shocks still occurring as they did. The implications for the economy were the same as in the figure above.
These counterfactual exercises serve as a nice complement to the on-going quasi-natural experiments that indicate monetary policy at the ZLB can still pack a punch. Yes, monetary policy is far from perfect. But it is also far from impotent as claimed by some QE skeptics.

This piece is cross-posted from Macro and Other Musings with permission.

One Response to "Assessing QE: Why Counterfactual Thinking Is Important"

  1. Tejas552   October 29, 2013 at 10:02 am

    I think the problem is that with QE and all that we don't know what the counterfactual is. You are claiming that without QE the economy would be lot worse off, but what if the economy had been a lot better off without QE? As usual in economics at the end it comes down to effects at different time horizons. Short-term QE makes at (feel) better off as equity and other asset prices are pushed up and as over-leveraged and otherwise failed institutions are prevented from exiting the market. In the long run we pay a price for it in the form of structural distortions and an even bigger crisis.