QE3?

Arguments for:

The dual mandate is getting lopsided. Inflation is low and falling; employment growth has stalled, and the unemployment rate is stuck above 8 %. Whatever trade-off or balance before, it has tipped recently.

We may have a double dip. We are on the verge of the third consecutive weak GDP quarter, if you consider that the 3% growth in the 4th quarter (revised to 4.1%) was two-thirds inventory accumulation. We’ve had the 3 consecutive months of weak employment growth. Add three consecutive months of negative retail sales. It adds up to stall speed.

There is no help from abroad—only harm.

Europe is in a broadening and deepening recession. The falling Euro may help them, but will hurt us. China is slowing. India is slowing. Brazil is slowing. We are on our own.

False arguments against:

Interest rates are already very low. True, and relevant. However, money and credit growth is crucial whatever interest rates are. We need money and credit growth. That’s why they call it “quantitative” easing. It’s not about interest rates.

Previous QE has done no good. Why should more?

Remember the counterfactual. Previous QE may not have been sufficient to restore prosperity, but that doesn’t mean it wasn’t necessary and effective (decreasingly so) to prevent worse. Banks have been hoarding excess reserves rather than making money-creating loans and investments. However, like everything else, excess reserves have diminishing marginal utility. At some point banks will get their fill of redundant excess reserves and start exchanging them for loans and investments higher on their utility schedules.

More valid arguments against:

The M2 money supply has finally started to grow along with an increase in bank lending. In the past 3, 6, and 12 months, M2 has increased 5.3%, 6.8%, and 9.3%. In normal times, this would be too fast. These days it might be about right, but will take time to have an impact. Caution: The meaning and significance of more money on deposit at banks may have changed. To some extent, people may just be parking excess cash balances at banks because of lack of attractive alternatives. So, it’s hard to know how to interpret the money supply numbers these days.

Monetary policy has been the only game in town. It’s time for fiscal policy.

This argument may be too political for my taste. Some critics say, correctly, that the Fed has been an enabler of politicians shirking their fiscal responsibilities. Perhaps it is time for the Fed to join the game of chicken.

A point worth making, although no one pays attention to it.

In my opinion there is a difference between the Fed doing more quantitative easing and QE3. The latter is an unfortunate term conjuring up images of huge ocean liners. While the FOMC didn’t give those labels to earlier easing programs, it did help encourage others to do so by giving expected amounts and beginning and ending dates. If it does more, it should at least avoid those mistakes.

Where I come out.

The Fed should announce that it is mindful of the need to keep money and credit growing moderately. Without mentioning timing or amounts, it should conduct its normal—or what used to be called normal—open market operations to prevent its total assets from shrinking. A chart of the Fed’s balance sheet shows no growth in total assets over the past year. Operation twist, by definition, sterilizes some securities purchases with sales of others. We need moderate non-sterilized net purchases.

 

Comments (1)

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  1. Benjamin Cole says:

    Bob McTeer–

    You are getting close. The Fed needs to announce a QE program that targets nominal GDP growth, and not a program of limited amount and duration.

    The anti-QE crowd is wrong for the reasons you suggest. but also because QE wasn’t big and bold enough. It is like giving a general too few troops, watching him lose, and then saying, “Why should we persist in this war? Let’s surrender.”

    Globally, interest rates have been trending down for decades, headed towards zero bound. Japanomics.

    This makes cutting interest rates (the traditional central bank tool) as effective as a firehouse against a flood.

    By default we have QE. The real policy questions going forward are what to do with central bank balance sheets (turn over to national treasuries?) and if central banks can operate without a lot more transparency in democracies. I mean. we are talking about our met unimportant policy-making organizations, and they should be clear and transparent.

    The Department of Defense has far more lethal consequences for mismanagement than the Fed, and no one suggest that it be independent.

    Bob McTeer, get out in front of these issues!
    N