Click amount to donate direct to CounterPunch
  • $25
  • $50
  • $100
  • $500
  • $other
  • use PayPal
Please Support CounterPunch’s Annual Fund Drive
We don’t run corporate ads. We don’t shake our readers down for money every month or every quarter like some other sites out there. We only ask you once a year, but when we ask we mean it. So, please, help as much as you can. We provide our site for free to all, but the bandwidth we pay to do so doesn’t come cheap. All contributions are tax-deductible.
FacebookTwitterGoogle+RedditEmail

The Fed’s Second Shot

The recent economic data leave little doubt that the economic recovery in the United States is anemic at best. There was much celebration over the November jobs report. This showed a gain of 151,000 jobs. This was better than the near-zero number anticipated by most economists, but should hardly provoke cries of joke. The economy must create 100,000 jobs a month just to keep even with the growth of the labor force, which means that it will take more than a decade at this pace to get back the 7.5 million jobs lost to date.

The picture painted by the data on third-quarter GDP, which was released the prior week, was even bleaker. Most reports focused on the 2.0 percent growth number, which was slightly higher than had been expected.

However these reports missed the fact that most of this growth was due to the extraordinary pace of inventory accumulation in the quarter. The rate of accumulation in the third quarter was the second-highest ever, adding 1.4 percentage points to growth for the quarter. Excluding this jump in inventories, the economy grew at just a 0.6 percent annual rate in the third quarter. If inventory growth returns to a more normal level, fourth quarter growth will likely be negative.

The Fed’s decision to try another round of quantitative easing must be understood in this context. The U.S. economy is operating far below its potential and is not likely to return to potential output any time soon without some outside boost. The Fed’s decision to buy $600 billion in government bonds over the next eight months is a step in this direction.

This is a follow up to an earlier round of quantitative easing announced at the beginning of 2009 in which the Fed bought $1.25 trillion of mortgage-backed securities and another $300 billion of government bonds. That move helped to bring down long-term interest rates and stabilize the economy at a time when it was sliding rapidly.

The new move should also help to lower interest rates; although the effect is likely to be limited. With long-term interest rates already at extremely low levels, it is unlikely that the Fed’s new bond purchases will lower them much further. A decline of 30-40 basis points would probably be the best that can be expected. This would lead to a somewhat smaller decline in private sector rates, like mortgage interest rates and corporate bond rates.

This will help to promote growth, but it is not likely to qualitatively change the basic economic picture. A modest drop in mortgage interest rates will not revive the housing market nor will lower interest rates lead to an investment boom. The positive stock market response may lead to some additional consumption through the wealth effect, but here too the impact is likely to be modest.

The largest effect will likely be on the value of the dollar. With the Fed quite explicitly determined to keep interest rates low, investors are likely to seek alternatives to dollar assets. This will cause the dollar to drop, which will in turn improve the U.S. trade balance. The downward drift of the dollar is something that must happen and a second round of quantitative easing may bring the drop about sooner.

Still, the Fed’s move is a disappointment. Given the severity and the duration of the downturn, $600 billion in bond purchases is a very modest measure. The more effective policy that the Fed opted not to pursue is inflation targeting. If the Fed targeted a moderate rate of inflation (e.g. 3-4 percent), it could change expectations and therefore behavior.

If businesses expected that prices for most goods and service would be 12-16 percent higher in four years, then they would be far more willing to undertake investment even in the current economic climate. A moderate rate of inflation would also help households escape from indebtedness. While their debt is fixed in nominal terms, if inflation raised wages by 15 percent then it would reduce the burden of the debt by 15 percent. This should also boost consumption and growth.

House prices should also rise roughly in step with inflation. A 15 percent rise in prices over the next four years would pull many people out from being underwater. It would add trillions of dollars to homeowners’ wealth.

The Fed’s holding of debt also has another benefit that has received far too little attention. Insofar as the Fed holds the government’s debt, the interest payments on this debt pose no burden for the government since the interest received by the Fed is refunded right back to the Treasury. Last year, the Fed refunded $77 billion in interest to the Treasury, an amount equal to nearly 40 percent of the government’s net interest payments. The Fed’s decision to buy and hold debt prevents the interest on this debt from posing a burden to the Treasury.

In short, QE II, as this second round of quantitative easing has been dubbed, is a positive step in the current economic situation. Unfortunately, it is not nearly enough to fully counteract the severity of the downturn.

DEAN BAKER is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of Plunder and Blunder: The Rise and Fall of the Bubble Economy and False Profits: Recoverying From the Bubble Economy.

This column was originally published by The Guardian.

 

 

More articles by:

Dean Baker is the senior economist at the Center for Economic and Policy Research in Washington, DC. 

October 17, 2018
John Steppling
Before the Law
James McEnteer
Larry Summers Trips Out
Frank Stricker
Wages Rising? 
Muhammad Othman
What You Can Do About the Saudi Atrocities in Yemen
Binoy Kampmark
Agents of Chaos: Trump, the Federal Reserve and Andrew Jackson
Karen J. Greenberg
Justice Derailed: From Gitmo to Kavanaugh
John Feffer
Why is the Radical Right Still Winning?
Dan Corjescu
Green Tsunami in Bavaria?
Rohullah Naderi
Why Afghan Girls Are Out of School?
George Ochenski
You Have to Give Respect to Get Any, Mr. Trump
Cesar Chelala
Is China Winning the War for Africa?
Mel Gurtov
Getting Away with Murder
W. T. Whitney
Colombian Lawyer Diego Martinez Needs Solidarity Now
Dean Baker
Nothing to Brag About: Scott Walker’s Economic Record in Wisconsin:
October 16, 2018
Gregory Elich
Diplomatic Deadlock: Can U.S.-North Korea Diplomacy Survive Maximum Pressure?
Rob Seimetz
Talking About Death While In Decadence
Kent Paterson
Fifty Years of Mexican October
Robert Fantina
Trump, Iran and Sanctions
Greg Macdougall
Indigenous Suicide in Canada
Kenneth Surin
On Reading the Diaries of Tony Benn, Britain’s Greatest Labour Politician
Andrew Bacevich
Unsolicited Advice for an Undeclared Presidential Candidate: a Letter to Elizabeth Warren
Thomas Knapp
Facebook Meddles in the 2018 Midterm Elections
Muhammad Othman
Khashoggi and Demetracopoulos
Gerry Brown
Lies, Damn Lies & Statistics: How the US Weaponizes Them to Accuse  China of Debt Trap Diplomacy
Christian Ingo Lenz Dunker – Peter Lehman
The Brazilian Presidential Elections and “The Rules of The Game”
Robert Fisk
What a Forgotten Shipwreck in the Irish Sea Can Tell Us About Brexit
Martin Billheimer
Here Cochise Everywhere
David Swanson
Humanitarian Bombs
Dean Baker
The Federal Reserve is Not a Church
October 15, 2018
Rob Urie
Climate Crisis is Upon Us
Conn Hallinan
Syria’s Chessboard
Patrick Cockburn
The Saudi Atrocities in Yemen are a Worse Story Than the Disappearance of Jamal Khashoggi
Sheldon Richman
Trump’s Middle East Delusions Persist
Justin T. McPhee
Uberrima Fides? Witness K, East Timor and the Economy of Espionage
Tom Gill
Spain’s Left Turn?
Jeff Cohen
Few Democrats Offer Alternatives to War-Weary Voters
Dean Baker
Corporate Debt Scares
Gary Leupp
The Khashoggi Affair and and the Anti-Iran Axis
Russell Mokhiber
Sarah Chayes Calls on West Virginians to Write In No More Manchins
Clark T. Scott
Acclimated Behaviorisms
Kary Love
Evolution of Religion
Colin Todhunter
From GM Potatoes to Glyphosate: Regulatory Delinquency and Toxic Agriculture
Binoy Kampmark
Evacuating Nauru: Médecins Sans Frontières and Australia’s Refugee Dilemma
Marvin Kitman
The Kitman Plan for Peace in the Middle East: Two Proposals
Weekend Edition
October 12, 2018
Friday - Sunday
Becky Grant
My History with Alexander Cockburn and The Financial Future of CounterPunch
FacebookTwitterGoogle+RedditEmail