SORRY, but this is not the way to run an economy. There was a case for quantitative easing (QE) at the start of the financial crisis, and conceivably more recently too, to prevent the money supply from collapsing, in the US, in the UK and elsewhere. But not today – and especially not in America. The US economy is growing, feebly but steadily; the money supply appears to be ticking up; housing has shown signs of life; and America has gone much further than the UK in writing off the malinvestment from the bubble years. Above all, the US economy is not on the brink of a precipice – so why did Ben Bernanke, the Fed chairman, announce a third wave of quantitative easing, with the vote a resounding 11-1?
A recent Bloomberg poll of US economists showed that just 20 per cent thought monetary policy was too tight prior to this latest batch of QE – with 32 per cent saying it was just right, and 49 per cent saying it was already too lose. Yet Bernanke even pledged to make QE3 unlimited, to buy far more private securities and to keep interest rates on hold until 2015.
His challenge is that the Fed has a dual mandate which includes not just controlling inflation but also minimising unemployment. Bernanke is also worried about America’s looming, frightening fiscal cliff.
But none of this means that he is right. While there is often a short-term trade-off between inflation and unemployment, and between increasing the money supply and “growth”, printing money is not a permanent solution. In the long run, real sustainable growth comes from entrepreneurs inventing better ways of conducting business, from investment in productivity enhancing capex financed from savings, and from more people finding viable jobs. Eventually, the short-term becomes the long-term – and that is where we are today. Cheap money is just a temporary fix – and like all drugs, the economy needs more and more of it merely to stay still now it is hooked.
America’s unemployment problem, and the shocking suggestion that median inflation-adjusted wages are now down to 1995 levels, are being caused by real, not monetary, factors. Millions of workers don’t have the right skills; printing more money won’t help them. The problem is not insufficient total demand, it is insufficient demand for certain skills which in many cases are now obsolete. The Fed thinks it understands this: it wants to jump-start the housing market, to boost construction employment, still 26 per cent below peak. It presumably also wants to boost house prices, thus increasing the net wealth of Americans and encouraging them to spend. But manipulating the housing and construction markets is a dangerous game that the Fed should not be playing; it would be better to allow the market to clear freely.
In a brilliant new paper for the Federal Reserve Bank of Dallas, William R White, one of the few economists to have predicted the financial crisis, warns of the disastrous unintended consequences of ultra easy money. He explains why there are limits to what central banks can do, that monetary “stimulus” is less effective in bolstering aggregate demand than previously, that it triggers negative feedback mechanisms that weaken both the supply and demand-sides of the economy, threatens the health of financial institutions and the functioning of financial markets, damages the independence of central banks, and encourages imprudent behaviour on the part of governments. If you still think Bernanke did the right thing, read White’s paper. Monetary policy is not a free lunch.