Last week we asked readers for their views on the priorities of the Federal Reserve Board of Governors. The most popular response was “reduce bond and securities purchases,” which received 43 percent of votes. “Gradually raise interest rates” and “provide more transparency” received 24 percent and a 19 percent of readers’ votes respectively. “Expand QE until unemployment is 6.5 percent” had 8 percent, and “offer clearer forward guidance” only had 6 percent support.
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While this was far from a scientific poll, the editors of e21 fully agree with our readers that reducing bond and securities purchases is the most important task for the Federal Reserve’s Board of Governors.
The Fed spends $85 billion a month purchasing Treasury bonds and mortgage-backed securities. Charles Calomiris, Columbia Business School Professor and Shadow Open Market Committee Member, told us back in August, “Tapering is already long overdue. The Fed is putting itself far behind the curve.” Over four years after the recovery’s beginning, might it be possible that the Fed's cure is worsening the economy's disease?
The Fed does not appear to have been particularly successful in rescuing the economy, although its fans say that the economy’s performance would have been worse without the Fed’s actions. The unemployment rate is at 7.3 percent, and would be in the 11 percent range if the labor force participation rate were not at 62.8 percent, the same level as in 1978 (read more here). Third quarter annualized GDP growth of 2.8 percent was stronger than expected, but due in large part to greater inventory investment that will depress growth in the fourth quarter. Personal and business expenditures declined (read more here).
Continued accommodative monetary policy by the Federal Reserve is unlikely to increase GDP growth. No country ever devalued its way to prosperity. If that were possible, then all countries would let their currencies depreciate and reap the rewards. But this does not happen. Instead, weak currencies drive up prices of commodities and discourage saving and investment.
The Fed’s policies are redistributing funds from small savers, who cannot get a return on their savings accounts, to owners of stocks and homes, who have seen the values of their assets skyrocket. Thrift is punished, spending—especially on credit—is rewarded. Inequality is exacerbated.
As soon as banks ramp up their lending, inflation will take off as it invariably has done after monetary growth.
The Fed’s implementation of QE3, purchases of more mortgage-backed securities and Treasury bills without an end date, was based on the hope that lowering already record-low interest rates will spur consumer spending. Low rates could be helpful in the initial stages of a recession. But these actions, following QE1, QE2, and Operation Twist, are likely having minimal effects on the economy this late into recovery—as can be seen by the latest economic releases.
Earlier this month, Harvard Economist Larry Summers, who was one of the leading candidates for Federal Reserve chairman, questioned whether Fed policies are helping economic growth. He said, “We may well need in the years ahead to think about how we manage an economy in which the zero nominal interest rate is a chronic and systemic inhibitor of economic activity… there’s no evidence of growth that is restoring equilibrium (read more here).”
Simply put, record-low interest rates and monthly purchases of $85 billion in Treasury bills and mortgage-backed securities have not succeeded in increasing employment and jumpstarting the economy. Janet Yellen, the next Federal Reserve chairman, should listen to our readers and seriously consider reducing the Fed’s monthly purchases.
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