What Is Quantitative Easing? The Case For Ending a Successful Program
When Ben Bernanke, the chairman of the Federal Reserve, appears before Congress to present his take on the outlook for the U.S. economy, you can be sure investors will be paying close attention. While the Fed may have begun outlining a plan to reduce bond purchases as the recovery continues to move forward, most analysts agree that the Fed is likely to continue quantitative easing for the foreseeable future. Weak jobs data earlier this month fueled speculation that talk of ending the controversial stimulus program was premature. It also serves as a reminder that, while the Fed’s policies have helped the market recover from the depths of the recession, they haven’t yet managed to bring unemployment down to pre-recession levels or boost wages for the average worker.
This reality has sparked disagreement among the Fed regional pesidents, with Richard Fisher, president of the Dallas Federal Reserve, as the most vocal critic of quantitative easing. Like other conservative market observers, Fisher worries that continuing purchases of bonds and other assets will inevitably lead to asset bubbles like the housing bubble that led to the great recession. Still, other members of the Federal Open Market Committee (FOMC) like Narayana Kocherlakota of the Federal Reserve Bank of Minneapolis and James Bullard of the Federal Reserve Bank of St. Louis insist the Fed can and should do more. What we can glean from these divergent viewpoints is that quantitative easing, like every policy, presents us with tradeoffs. At some point the costs outweigh the benefits, and without expansionary fiscal policy to support it, quantitative easing may have reached that point.
In the wake of the financial crisis, the Fed needed to intervene with an aggressive monetary policy. Banks became extremely risk-averse and needed incentives like extremely low interest rates and easy money to begin issuing loans. When slashing interest rates wasn’t enough, the Fed pursued the previously untested policy of buying assets like mortgage-backed securities and long-term bonds as a signal to banks that they could get used to a low-interest-rate environment and operate accordingly. The Fed didn’t count on a contractionary fiscal policy suppressing demand for new goods and services, and is realizing the limitations of its policies.
This chronic lack of demand is the biggest reason for the slow pace in job growth and also the reason conservative economists have been wrong about the inflationary impact of quantitative easing. While banks may be sitting on mountains of cash, it’s not circulating in the wider economy because they don’t know who to give it to. Despite low borrowing costs for banks and significant cash reserves, small-business owners have found it increasingly difficult to receive loans. As it turns out, banks still don’t have much of an appetite for risk following the financial crisis and need to see signs that there is sufficient demand for new goods and services for these small businesses and startups to become successes. Ironically, this unwillingness to issue loans is keeping investment spending down, unemployment high, and wages stagnant — a perfect recipe for a demand shortfall that leads to defaults on small-business loans.
The Federal Reserve has done its part in creating an environment where rapid expansion should be possible. It is time for the Fed to take its foot off the gas and end quantitative easing. While this will likely cause stock prices to fall, it will force banks who have utilized cash reserves as a hedge on risky investments in the equities market to start taking on more risk in issuing loans if they want to continue to increase profits. This will get the money out of the banks and into the hands of entrepreneurs who will hire workers and speed up the recovery.
With a Congress paralyzed by politics, the economic recovery has been left at the feet of the Federal Reserve and monetary policy. The Fed has to create new incentives for banks to give out the money it’s been pumping into them for the past four years. In a counterintuitive way, the strongest incentive might just be an end to quantitative easing.