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Quantitative easing is not the Titanic

A second round of quantitative easing could boost the US economy, help ordinary working Americans, a

While last week's US midterm elections continue to be dissected on both sides of the Atlantic, less attention was paid to the Federal Reserve's decision to embark on a second round of quantitative easing, even though this may have a greater impact on the US economy. Those who have focused on the Fed's decisions have been generally critical, the former Reagan administration official David Stockman calling it "pure monetary heroin" and other pundits predicting that it will spark a global trade war. That noted monetary policy expert, Sarah Palin, has even taken a break from her reality TV show to conjure up fears of hyperinflation, a worthless dollar and a situation where the Federal Reserve becomes "not just the buyer of last resort, but the buyer of only resort".

On one level, people are right to be sceptical. The Bush administration argued in 2008 that only drastic action could prevent depositors from losing their money and firms' temporary lines of credit drying up, claims that the Federal Reserve Bank of Minneapolis debunked in a study days after the bailout was finally agreed. Similarly, the purchase of $1.25trn worth of mortgage securities in early 2009 failed to prevent the rate of growth of broad money (M3) falling into negative territory this summer.

With US unemployment at 9.6 per cent, the only thing that the interventions seem to have achieved is to enable parts of the financial sector to escape the consequences of their own actions. As an "added bonus", the public backlash has helped elect a Congress committed to extending tax cuts for the rich and rolling back Obama's health-care reforms.

However, by purchasing long-term government bonds, which are more likely to be held by households and non-financial corporations than mortgage securities, a greater proportion of the monetary stimulus will find its way directly into the money supply, rather than relying on increased lending. This in turn should boost economic demand and prevent deflation, which is a very real possibility and would delay the process of economic recovery. That the intervention will involve the purchase of a low-risk asset, instead of securities of uncertain value, will reduce the risk of losses to the US Treasury without further rewarding those who lent and invested recklessly.

Even the warnings from the World Bank that the intervention will lead to a weaker dollar are disingenuous. Since the mid-1970s America has run a continuous trade deficit, importing more goods and services than it exports. This deficit, and the consequent borrowing that was used to cover for it, have now been recognised as one of the main causes of the financial crisis, making a solution imperative for America's long-term future.

Because the only other alternatives are deflation, which would further increase unemployment, and protectionism, which could spark a trade war that could tip the world back into recession, letting the dollar slide is the only plausible solution. Worryingly, protectionist sentiment continues to grow, with a poll conducted in September showing that 69 per cent of Americans believe that free-trade agreements destroy more jobs than they create.

Of course, some risks still remain. While an increase in the money supply is needed to speed recovery and prevent deflation, too great an injection will be inflationary. It is also important to make sure that the Federal Reserve sticks to purchasing government bonds from households and consumers, rather than reintervening in the mortgage market or buying securities from banks or financial institutions (which would only increase the monetary base).

The Federal Reserve needs to increase transparency by publishing the basic broad monetary aggregates that other central banks compile, including those that it discontinued in 2006, rather than forcing economists to rely on composites produced privately. There is also the question of why it has taken Bernanke so long to arrive at a solution that would have avoided much of the cost, moral hazard and public anger generated by the bailouts.

Matthew Partridge is a freelance journalist and a PhD student at the London School of Economics.