Quantitative Easing in the US - Some Thoughts

Quantitative Easing or QE refers to massive programme of buying bonds with newly printed money. This QE was initiated in the wake of sub prime crisis of 2008 when Lehman Brothers collapsed and there were serious question marks on other financial institutions. Liquidity had dried up from the market, as even banks were vary from lending to each other, as they doubted others net worth.

Over the past five years, the Fed has invested bought more than $3 trillion in the US Economy in its effort to encourage job creation According to Mr. Ben Bernanke, the programme was “well on its way to meeting our economic objective of putting economic recovery on a path to sustained improvement.”

The Fed began its current, that is third round of QE in September 2012, and unlike previous rounds, made it open ended that is, it would continue until the labor markets outlook had clearly improved.

Starting Jan 14, the Fed will trim its monthly pace of bond purchases for $85 billion to $75 billion. Thereafter the Fed will likely reduce the pace of asset purchases in further measured steps at future meetings. Bernanke expects QE would come to a halt by late 2014, but he emphasized this was contingent on growth of 3% and fall in unemployment to around 6.5%.

More importantly, tapered QE was coupled with a stronger commitment to keep the short term interest rate target at zero. The Federal Open Market Committee had previously said it would stay at zero at least until unemployment had fallen below 6.5%. On 18^th December it said it would stay there “well past the time” that unemployment drops below 6.5%, especially if projected inflation continues to run below its 2% target. That, according to FOMC member’s projections means until 2015 or later.

Current GDP growth stands at around 2.2% and inflation are at 1.5%. Bernanke indicated he thought the drop in inflation was due to transitory factors, such as a slowing rise in health costs, and that it would drift back to 2%.

 Though the overall sentiment has improved in the last five years, notwithstanding the crisis over the budgetary allocations which shutdown the US govt temporarily, yet the key question which needs to be answered is:

Was QE resulting in the flow of money to other emerging markets, and increase in the prices of precious metals such as gold and silver?

Well, the immediate reaction after the announcement regarding the tapering QE seems to suggest the same.

While Fed’s decision would be determined by two key parameters viz the GDP growth rate and the unemployment levels, yet it would be a Herculean effort determine the extent of correlation between QE, and these two key indicators of the US economy.

According to some media reports, it is entirely possible that the tapering decision will prove premature.

The Fed terminated two previous rounds of QE, only to restart them when the economy faltered and deflation fears flared.

Consider the following:

• The number of Americans filing new claims for unemployment benefits rose in week ending 15^th December, to the highest level in nine months, casting a shadow on the labor market. Initial claims for state unemployment benefits increased 10,000 to a seasonally adjusted 379,000. that was the highest level since March and marked the second straight week that claims have risen,
• Given the need for overcoming the fiscal cliff and standoff between the Republicans and Democrats over the need to enhance the overall spending limits of the current US administration to accommodate Obamacare, and other populist measures of the Govt, can the Fed by cutting down and hopefully eliminating the QE by end of 2014, expect the US economy to achieve the desired results?
• The US govt shutdown over October 1-16 after the US Congress failed to clear a new budget. About 800,000 workers were furloughed and another 1.3 million workers worked without any set pay dates. Total loss was estimated at $24 billion and 0.25% shaved off from US’s GDP,
• A huge debt burden forced Detroit to file for bankruptcy after struggling to provide even the most basic needs – like police, fire and medical services to its 700,000 citizens. At $ 18.5 billion, it was US’s largest municipal bankruptcy
• $300 billion in packages committed to Japan, and
• President Obama’s pet healthcare overhaul was nearly derailed by an unresponsive site healthcare.gov. Problems arose after it went live on Oct 1, forcing President Obama to apologize. It cost over $1 billion to set the website right.

The above facts leave no room for doubt that the overall spending by the US govt, has to increase notwithstanding Fed’s decision to begin tapering next month, and ending QE by end 2014.

This essentially means that nevertheless, the overall fiscal deficit will keep bloating, resulting in an increase in the money supply in the US economy. Even if Fed were to put an end to QE3 by end 2014, the flow of money within the US economy cannot ebb until the key issue of fiscal deficit, primarily resulting from the above factors is not addressed by the US govt. If the global jitters witnessed last December, over the standoff on fiscal cliff are any indication, one wonders if there is any other way out for the US administration, other than to keep printing dollars for quite sometime, as it just cannot lose sight of the above facts.   

             

This leads to the following questions:

• Are the key indicators of the health of US economy – unemployment rate and GDP growth rate, solely dependent upon its monetary policies,  or do its fiscal policy and other factors such as the state of its key trading partners also have a role to play?
• Then, while attempting to remedy a serious situation like the one confronting the US in 2008, was it not appropriate for the Fed and US state treasury to go hand in hand?

My take on the above two questions are as follows:

Firstly, the key to an economy’s revival is increased internal and external consumption (local consumption and exports), of domestically produced goods and services, followed by increased employment levels of its citizens. It is here that the role of fiscal policy assumes significance, by providing a strong impetus to domestic industry through various incentives, both direct and indirect,

Secondly, the US administration should have ensured that a major portion of the $3 trillion which Fed has invested over the past five years through QE, was spent on creating long term infrastructure, to make the US economy more competitive and resilient, as compared to its most formidable economic rival China,

Thirdly, as European Union and Japan are still struggling with their economic revivals, it would be a good idea for the US Fed to buy bonds issued by the European Central Bank and the Bank of Japan with the condition that the use of  money would have either  direct or indirect linkages to the US economy.  It is expected that the $300 billion aid to Japan has either direct or indirect linkages to the US economy,

And finally, as part of its efforts to boost local employment levels, which would be the key to boost aggregate demand in the economy through increase in private consumption thereby leading to multiplier effects in the economy, the US govt could make the incidence of corporate taxes in inverse proportion, to the aggregate tax contributions by a corporate’s employees who are US citizens or at least green card holders.