by Calculated Risk on 9/16/2012 01:29:00 PM

From Paul Krugman: How Could QE Work?

[A]t this point it’s not at all clear that we have an overhang of excess housing capacity; we might even have a shortfall.

And we’re seeing a modest housing recovery starting ...
...
This means that we actually can hope that the Fed’s new policy will boost housing as well as operating through other channels, and therefore that it can act more like conventional monetary policy in fostering recovery.

That said, I’m still skeptical about whether monetary policy alone can come close to doing enough — a skepticism shared by Ben Bernanke:

So looking at all the different channels of effect, we think it does have impact on the economy, it will have impact on the labor market but as again, the way I would describe it is a meaningful effect, a significant effect but not a panacea, not a solution for the whole issue.

We still need fiscal policy. But it’s good to see the Fed doing more.

This is similar to the argument I made last weekend:

[O]ne of the key transmission channels for monetary policy is through residential investment and mortgages. The previous rounds of QE (and "twist") have lowered mortgage rates and allowed homeowners with excellent credit and income to refinance. However this channel has been limited ...

As residential investment recovers, and house prices increase (or at least stabilize), this channel will probably become more effective.

Last month I summarized some of The economic impact of a slight increase in house prices. This includes mortgage lenders and appraisers becoming more confident in the mortgage and housing markets. I think that is starting to happen, and I think QE might have more traction now through the housing channel.

Note: Krugman's comment on "overhang of excess housing" is very important. Although there isn't good timely data on household formation and the housing stock, I do think most of the excess supply has been absorbed.

For another view on QE3, see Jim Hamilton's: Effects of QE3

I think the correct interpretation of QE3 is that the Fed has unambiguously signaled that it's not going to re-run the Japanese experiment to see what happens when the central bank stands by and watches wages and prices fall even while unemployment remains very high. The Fed can and will keep U.S. inflation from falling much below 2%, and that may help a little. Investors should expect that, and not a whole lot more.

And for those who think commodity prices will soar, I suggest Michael Pettis' analysis of supply and demand: By 2015 hard commodity prices will have collapsed

Yesterday:
• Summary for Week Ending Sept 14th
• Schedule for Week of Sept 16th