Wall Street Journal

QE wasn't a welfare program

January 17, 2014: 1:59 PM ET

The notion that the poor benefited more than the rich from the Federal Reserve's bond buying program is silly.

Not quite Robin Hood

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FORTUNE -- Did the Fed do the poor a solid?

A common knock on quantitative easing, the Federal Reserve stimulus program, suggests just the opposite: The interest rate lowering program mostly benefited the rich. That was one complaint made by Larry Summers, the former Treasury Secretary who the White House seemed close to appointing as head of the Fed before he dropped out of the race. He said QE likely made inequality worse.

Earlier this week, though, the Wall Street Journal staked out the contrary ground. The article said that the individuals who benefited the most from QE were the young and the poor. The article's simple logic -- too simple -- was that the young and the poor are the most in debt. So lower interest rates benefit them the most. Rich people with lots of money stashed in the bank, not so much.

"Were these effects part of a grand design to stimulate the economy through more corporate investment, household spending and a healthier financial sector, or a clumsy and unintended redistribution of wealth caused by extraordinary measures?"

There are a number of problems with the argument that leads the Journal to this dubious question, but the biggest one is this: Stocks. The article says almost nothing about the stock market, only making a passing reference to the fact that other articles about the Fed's policies have talked about "asset prices." And not just stocks, but also bonds and houses, and investments in general. In other words, an article that was trying to draw a conclusion about how QE affected Americans' wealth completely ignored the very thing that contains the bulk of Americans' wealth.

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And you know who holds more stocks than anyone else? The rich. A lot more than the poor. (That's how these things work.) So to believe that QE benefited the poor more than the rich, you have to conclude that stocks over the past few years have gone down, which they have not (they've gone up, by a lot) or that QE has had no impact on the market.

The latter notion was argued in a recent McKinsey report, which appears to be the impetus for the WSJ article. Simple -- again, too simple -- logic would suggest the McKinsey report is wrong: We have had a lot of QE. Stocks have gone up a lot. QE made stocks go up.

But the McKinsey report, which was published in November, dives a little deeper. If QE has been driving stocks, then any announcements about QE would cause stocks to jump or fall. They say the stock market reactions to news about QE have been mild, and temporary. For example, the report says the market barely dropped when the Fed made it official in mid-June that it was considering pulling back on bond purchases. The market quickly began to rise again. Same thing but in reverse in mid-September, when the Fed put off the taper.

But the report is looking at the wrong dates. Bernanke first hinted about the taper on May 22. From the beginning of the year until then, the stock market was up 17%. From that time until Sept. 18, the day before Fed put off the taper, the market rose just 3%. Since then, the market is up another 8%, of which just 3% of that return has occurred since Dec. 18, when the Fed actually began to cut its bond purchases.

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Another piece of evidence, according to the report, that QE has not boosted stock prices is the price-to-earnings ratio. If QE had been giving stocks a boost and not earnings, you would expect P/E ratios to go up. But the report says the stock valuation metric is not above historic norms. The report has a chart that shows that fact.

But that was in November. I talked to one of the McKinsey report's authors, Richard Dobbs, and I had him update the chart in the report. Here's what it looks like now:

01.16.2014 SP500 PE Chart

See that spike at the end? P/E multiples are now well above norms, even when you exclude periods of inflation. Dobbs says the fact that the P/E ratio spike came in 2013 is proof of his point. Investors still bid up stocks even after it became clear that the Fed was going to pull back on bond purchases. But QE hasn't ended. The Fed is still buying $75 billion in bonds a month, which is less than the $85 billion a month it had been purchasing, but not by much. What I think you are really seeing here is that earnings growth has slowed, but investors' appetite for stocks has not. Is that because of QE? It's as good a guess as any.

Dobbs' final point on how QE has benefited the poor: It has driven down interest rates, and QE has made it cheaper to borrow. That has put off austerity efforts that would cut spending on welfare programs. But it hasn't. Both the U.S. and Europe have cut back on social spending. Dobbs argues that without QE the cuts would have been deeper. But I'm not sure how he gets to that. Yes, higher interest rates would have meant higher deficits, but that doesn't necessarily mean Washington would have decided to cut any more.

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QE has been one of the largest and most persistent stimulus program that the government has enacted since the financial crisis. The Fed has bought roughly $3 trillion in bonds. So if it really benefited the poor more than the rich, then you would expect some rebalancing of wealth. But, in fact, the opposite has occurred. Earlier this week, a Stanford study found that wealth inequality has risen faster since the recession than it had in the nearly two decades before.

The real danger in this thinking is that with QE in place some may say we don't need programs like food stamps or unemployment insurance, programs that do actually benefit the poor and not the rich. Put another way: There may be a lot of valid reasons to dislike like QE. It's creating a bubble. It's not actually boosting lending. But the argument that it makes the poor richer should not be one of them.

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