The Federal Reserve's "Trade War": Stimulating America's Energy Revolution?

The Federal Reserve's "Trade War": Stimulating America's Energy Revolution?

10/16/14

Samuel Rines

Domestic Politics, Economics, Energy, United States

"Domestic oil production is high cost, and QE has held the Dollar down and the price of oil up. With QE coming to an end, the shale revolution will have to stand on its own..."

There is no doubt the Federal Reserve’s policy of quantitative easing, or “QE”, has influenced markets both at home and abroad. But it seems even policy makers may be misinterpreting precisely how it has affected the U.S. economy. Low interest rates are only part of the picture, and the Fed appears to have succeeded there. The Fed’s QE policy may very well have worked—just not in the way Fed officials think it did.

It is worth remembering that QE is simply the purchasing of assets by the central bank with newly created reserves. This increases the size of the Fed’s balance sheet substantially. There are myriad suggestions about the transmission mechanisms through which QE works (and whether it works at all). Some forms of QE target a specific interest rate—this is known as “credit easing”—whereas general QE is simply meant to increase the size of the balance sheet. Former Federal Reserve chair Ben Bernanke stated the Fed was undertaking credit easing, indicating that the aim was to lower long-term interest rates. But, importantly, it also raised the number of reserves as a consequence. It was QE—just with a more specific aim.

QE played a role in driving down the value of the U.S. Dollar. This happens as investors search for better returns in their portfolios of risk assets. Money flows to smaller countries with relatively higher yields and returns, and this drives the real exchange rate of the larger country’s currency—in this case the U.S. Dollar—lower. Raghuram Rajan, the head of the Reserve Bank of India, stated earlier this year at the Brookings Institution that “some advanced economy central bankers have privately expressed their worry that the QE ‘works’ primarily by altering exchange rates…” In other words, without the effect that QE has on exchange rates—lower for the U.S. Dollar—there may not be much of an effect at all. This is a far more significant admission than it initially appears.

Read full articlehttp://nationalinterest.org/feature/the-federal-reserves-trade-war-stimulating-americas-energy-11476