Unexpectedly Intriguing!
14 April 2015

Near the end of the third quarter of 2012, the U.S. economy was heading toward a mild-to-moderate recession. In response, the Federal Reserve initiated a new round of its Quantitative Easing (QE) programs, QE 3.0, in which it would purchase $40 billion worth of Mortgage-Backed Securities (MBS) each month to try to prop up a fading U.S. housing market.

Three months later, the Federal Reserve recognized that a number of very large tax hikes on both working Americans and investors would take effect on 1 January 2013, an outcome that was ensured by the re-election of President Barack Obama, which would send the U.S. economy into deep recession unless it acted to expand its QE programs. In December 2012, the Fed announced that it would also begin purchasing $45 billion worth of U.S. Treasuries, which we identify as QE 4.0, which would offset the negative economic impact of President Obama's desired tax increases.

The Federal Reserve's combined QE programs were successful and are the only reason the U.S. economy avoided recession. In 2014, the Federal Reserve tapered off its purchases of both MBS and U.S. Treasuries, terminating both in December 2014.

Since we now have the finalized data for the U.S.' nominal Gross Domestic Product through the end of 2014, we can now update our counterfactual analysis of how the U.S. economy would have performed in its absence. The chart below reveals how nominal GDP evolved from 2012-Q1 through 2014-Q4:

Nominal U.S. GDP, With and Without QE 3.0/4.0, 2012Q1 through 2014Q4

Here are the basic findings of our analysis:

  1. Government spending cuts resulting from the federal budget sequester had a minimal impact on nominal GDP, contributing no more than about 10% to the fiscal drag acting on the U.S. economy.
  2. Around 90% of the fiscal drag imposed on the U.S. economy after 2012-Q3 came from tax hikes imposed in 2013.
  3. The U.S. economy experienced a temporary burst of organic economic growth in 2013-Q3 and 2013-Q4, which corresponds to a record harvest for nearly all major crops grown in the U.S. at high prices (in 2013-Q3), which was sustained in 2013-Q4 with their export to foreign markets, most notably China.
  4. In the absense of that economic activity, nominal GDP collapsed back to the level supported by the Federal Reserve's QE efforts in 2014-Q1.
  5. Some organic economic growth returned to the U.S. economy in 2014-Q2, as the U.S. economy finished its adaptation to the tax increases that had been imposed in 2013. That adaptation is what allowed the Fed to begin tapering its QE 3.0 and 4.0 programs.
  6. Strong organic growth returned to the U.S. economy in 2014-Q3 in response to falling oil prices, as domestic U.S. oil producers initially held off on cutting back their production.
  7. In 2014-Q4, the growth rate of nominal GDP fell off sharply from its pace in 2014-Q3 as domestic U.S. oil producers were forced to cut back their operations and investments to remain solvent, even though lower oil and fuel prices continued to enable growth in other sectors of the U.S. economy.

And that closes the books on QE 3.0 and 4.0!

About the GDP Multipliers Used in Our Counterfactual Analysis

The Multiplier Effect - Source: Lion Investing We featured a discussion of the fiscal multipliers for government spending and tax policies in our previous discussion of Spain's disastrous economic choices of 2012. At present, we're continuing to assume that the fiscal multiplier for the Fed's quantitative easing programs is approximately 1.0, in the absence of data that might contradict that figure. As yet, there really isn't any data to contradict this estimate, although with the latest GDP revision, the data suggests the multiplier rounds down to that figure.

Data Sources

Board of Governors of the Federal Reserve System. All Federal Reserve Banks - Total Assets, Eliminations from Consolidation. [Text Document]. Accessed 13 April 2015.

Cloyne, James. What Are the Effects of Tax Changes in the United Kingdom? New Evidence from a Narrative Evaluation. [PDF Document]. CESIFO Working Paper No. 3433. April 2011.

Owyang, Michael T., Ramey, Valerie A. and Zubairy, Sarah. Are Government Spending Multipliers Greater During Periods of Slack? Evidence from 20th Century Historical Data. [PDF Document]. Federal Reserve Bank of St. Louis. Economic Research Division. Working Paper 2013-004A. January 2013.

Romer, Christina D. and Romer, David H. The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks. [PDF Document]. March 2007.

U.S. Bureau of Economic Analysis. National Income and Product Accounts, Gross Domestic Product: Fourth Quarter and Annual 2014 (Third Estimate). [PDF Document]. 27 March 2014.

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