THE FINANCIAL TIMES
Bernanke ponders QE2 to keep America afloat
By Robin Harding
Published: September 24 2010
It was not supposed to be this way. After tens of billions of dollars in bank bail-outs, hundreds of billions in fiscal stimulus, and trillions more in bond purchases by the Federal Reserve, the US economy was supposed to be fixed. This should have been the year of growth, and robust growth at that. Ben Bernanke, the Fed chairman, was meant to be anticipating his “central banker of the century” award, and enjoying a well-earned rest.
No such luck. Growth stalled over the summer; unemployment is stuck at a painfully high 9.6 per cent; and core consumer prices, excluding food and energy, rose by only 0.9 per cent in the year to August – much too close to zero for comfort. As a result the Fed is girding itself – with considerable reluctance and not a little self- doubt – for one last heave.
After their regular conclave in Washington this week the Fed’s rate-setters said they were “prepared to provide additional accommodation if needed to support the economic recovery”. This might not sound like fighting talk, but the markets knew it meant “we will be buying bonds again unless the economy perks up soon”. Buying bonds is a form of quantitative easing, so its likely return has quickly been nicknamed “QE2”.
While this return outing is not something the Fed wants to do, it has gradually been backed into a corner. The institution’s twin goals are high employment and stable prices. In recent months it has failed to achieve either. The Fed could stomach this if it was confident of strong growth over the next couple of years and, to be fair, it still thinks there is a good chance that the economy will bounce back. But after a summer of weak data the risk that it may not is becoming intolerably large.
Nor can the central bank expect any help. With Larry Summers departing, the White House economic team in flux, and President Barack Obama increasingly embroiled in America’s midterm elections, the Fed is the only outfit in town with a shot at propping up America’s weak recovery. Mr Obama’s earlier fiscal stimulus is also already starting to fade, and election year politics have poisoned the chances of any more. Austerity in Europe and yen intervention in Japan mean that foreign demand is also unlikely to provide much of a boost. In short, only Mr Bernanke can act. The question is whether the Fed can accomplish what may be asked of it.
Further complications come in the way the cash injection works. Imagine that, as you read this, the FT generously decides to transfer a million dollars into your bank account, and that of every other reader. That would put many billions into the economy. Now, what are you going to do with the money? Before you quickly turn to How to Spend It, there are a few conditions.
First, this is a loan and not a gift. We will decide when you have to pay us back. Second, we will not tolerate inflation, and if your reckless use of our money starts to push up prices then we will demand it back immediately. Third, we intend to take some long-term assets, like your house or savings, as security. Taken together, this is a bit like the way QE works. And given the conditions have a big effect on the way the cash is used it is crucial to get them right.
The Fed wants QE to work through condition three. By giving out cash and taking in securities Mr Bernanke leaves the public with more short-term and fewer long-term assets. That should cause interest rates on long-term assets to fall, making it cheaper to borrow for consumption or investment, and thus boosting the economy.
But there are problems. Nobody is really sure how much QE pushes down long-term interest rates but it appears to take a lot of it to make a difference. The more assets the Fed buys, however, the greater the chance that it will make a mistake, like triggering inflation, and the harder it will be to sell them smoothly when the time comes.
If nobody is willing to borrow and spend, meanwhile – and in particular if battered consumers are busy saving after the financial crisis – then lower rates may do less than usual to boost the economy. That is why there is also a case for the Fed to look at changing the first or second conditions on QE: the time frame for which it will stay in place, and the promises never to let it turn into inflation. Changing either would affect what you did with your million dollars. If you knew that you would not have to pay it back for several years then you might invest it. If you thought there might be inflation it makes sense to spend now, because it would be worth less when you had to repay.
The notion of a policy to promote inflation, however, remains hugely controversial. Mr Bernanke has rightly opposed the suggestion that the Fed should raise its tacit goal for inflation from 2 per cent to 4 per cent, a policy suggested by IMF chief economist Olivier Blanchard among others. That threatens the Fed’s hard-won credibility in controlling inflation and could do more harm than good. That said, the point of QE is to ensure moderate inflation in the future, rather than a slide into deflation and recession. If the Fed does not foster those expectations, then it strips the policy of its power.
There are ways the Fed could do this, however. It could promise to keep loose monetary policy in place until the economy grows to a certain size, or allow just enough extra inflation to make up for slower price rises during the recession. Mr Bernanke, at least, is confident. In a speech at Jackson Hole in August he made an unusually definitive statement for a central banker. “The issue at this stage is not whether we have the tools to help support economic activity and guard against disinflation. We do,” he said. There is no reason to doubt him. But the time to use all those tools is now at hand.
The writer is FT US economics editor
Obama's economic plans aren't working and the American public are sick and tired of it! I have a difficult time believing that if McCain had been elected he wouldn't have done a much better job than Obama by now.