Does the world need more QE from the Fed?

By Guest Contributor
October 14, 2010

- Kathleen Brooks is research director at forex.com. The opinions expressed are her own -

The minutes from the Federal Reserve’s September meeting seems to suggest that more quantitative easing is a done deal for November. So far, the argument has centred on whether or not the U.S. economy needs another shot in the arm from the Fed to boost growth. The Fed certainly thinks it does. According to the minutes “many” members felt that the status quo – sluggish growth, inflation grinding lower  and no sign of a recovery  in the jobs market – was enough to justify more easing in policy.

These are pretty compelling reasons for more QE to stimulate the flagging U.S. economy, but what about the rest of the world? Any action by the Fed has huge implications for the global economy. Usually, when the Fed shifts its stance from easing to tightening or vice versa it starts a global chain reaction.

But now that we are in unusual times, the Fed’s actions are even more important. Turning on the printing presses will have three main consequences. Firstly, it may not have the desired effect on the U.S. economy. If it doesn’t make companies hire more staff, and corporations continue to sit on huge cash piles, then the liquidity generated by the Fed will start to seep out of the US economy.

If you can borrow cheaply but don’t want to expand your business, perhaps because you don’t have strong enough faith in U.S. householders who are busy retrenching and paying off debt rather than spending, then you’ll chase returns elsewhere. This will create liquidity bubbles. The immediate beneficiaries will be stocks and commodities. We have already seen gold reach new highs, and equities are looking like they are popping up. It’s great if you are at the receiving end of the liquidity, however if you are not, then you’ll be left out in the cold.

If the U.S. doesn’t boost demand with more QE, then domestic retailers will soon feel the chill of prolonged high unemployment. Likewise, if the money chases investments in high-growth economies, then it will leak to emerging markets, by-passing the sluggish, debt-laden west.

Capital inflows to emerging markets is what is fuelling the so-called “currency war”. While capital flows will put upward pressure on local currencies across emerging economies, the market hasn’t been focusing on the real problem – the prospect of Fed money fuelling the next financial bubble. In this sense, authorities including Brazil and Thailand who have imposed capital rules to try and stem the flow of money into their asset markets, have done not only to keep their export markets competitive, but also to prevent unsustainable asset price bubbles.

These economies learnt harsh lessons from the Asian and Latin American financial crises of the 1990s. That is why the U.S. should consider the implications of turning on the printing presses, and ensure that the extra money it produces targets the real problem: how to ignite U.S. demand.

Comments

The Fed will try to push inflation higher with a new round of QE that will likely be announced at the November meeting.

With excess bank reserves sitting near $1 trillion, it is unlikely that new bond purchases will encourage a spate of new lending.

But just talk of QE2 has hit the dollar, boosted commodity prices and modestly pushed up inflation expectations, which the Fed hopes will force consumers to speed up buying decisions.

It’s a huge gamble, and one that will probably cause more problems than it solves.

CS
http://www.economy-tomorrow.com

Posted by TomEcon | Report as abusive
 

I don’t think the current U.S. financial environment needs an additional easing; QEⅡ. At this point, further expansion of the Fed’s balance sheet could be more harm than benefit. It’s too early to square up the widely-scattered opinions at this point. We would have to contemplate the cost and benefit of the additional asset purchases with an eye to the exit. I’m the one of those who are seriously worried that the excess liquidity begins to exert a bad impact on the unintended area such as commodity markets or emerging countries.

On the other hand, the level of the price is certainly too low as financial officials seriously express their concerns. Being very difficult to conquer the deflation once we would be trapped by, we should reduce that risk whatever it’ll take right now. So I assume that the setting of the simple and clear-cut price-level target is very effective to stabilize and then increase the price.

Taking into consideration the fact that the recovery in the function of interest rate is a prerequisite condition for the health of the financial system, the current U.S. economic condition provide a strong reason for the efficiency-oriented action to boost the price.

Posted by Ayako | Report as abusive
 
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