ECON430-Topic #3: To QE3 or not to QE3?

The FOMC has long been rumored to be considering additional asset purchases along the lines of a third quantitative easing program or QE3 due to the fact that the economy remains rather soft. While these rumors are mostly fueled by the media, the Fed has stated that it is open to further asset purchases if the economy does not improve. Some further deleveraging in the economy might need to occur, which might be keeping the pressure on the Fed to keep an easy money policy. However, many pundits are worried about a continued easy money policy hurting the credibility of the Fed. Some predictions are for core inflation to rise up near 2.7 or 2.8% before coming back down. If this is the case, the Fed might be missing its target in the near term, while still focusing on their long-term goal. Jan Hatzius with Goldman Sachs noted a few reasons to continue believing in further easing by the Fed, one of which is that failure to ease further might be equated to tightening.

For what it is worth, recent Fed statements have said that while the economy is improving, there are still downside risks to growth in the near term. Keeping policy unchanged for the time being is the FOMCs current course of action, but they may shift course by the end of summer if pundits and market analysts are correct.

Questions you might consider

  • Find some data that supports the claims made by those that the Fed might need to consider further easing. Why is the Fed considering these actions, and what do they hope to accomplish if they do ease further?
  • Go back and look at the impacts of QE2 and/or Operation Twist to see if what the Fed has done in the past had something approximating its desired impact. I’m hoping for data to support your opinion here on further easing or halting to easing. If you want easing halted or reversed, show evidence on inflation beyond an anecdote from a manufacturer seeing his profits squeezed by higher fuel prices.
  • Examine profit margins in the last few years since quantitative easing has begun. Is there evidence that inflation is eating away at profits? Are consumers being harmed by ever higher inflation that is not captured by the Fed’s inflation measure? Try to stick to reputable sources when answering these questions.

10 thoughts on “ECON430-Topic #3: To QE3 or not to QE3?”

  1. I’m beginning to believe most data indicating today’s trends in pricing, consumption and investments as a means of future economic forecast is irrelevant. Coupled with irrelevancy, data can be interpreted and misinterpreted in multiple ways. Take the following point: the Fed is forecasting rates of unemployment between 6.7 and 7.6 by the end of 2014 (1). Compared to an unemployment rate of 8.3 that we see today, these forecasts seem reasonably optimistic.

    It turns out the message the Fed is relaying may be equally important in making these lower unemployment rates come true. If people believe things are getting better, they may spend more money today and save less today. This may lead to higher economic output and subsequent lower unemployment in the near future, 2014. It may not matter whether these unemployment forecasts are accurate at all—the positivity through the Fed’s message may actually do the work, although it is hard to say.

    Let’s assume the forecasts are accurate and that unemployment will drop by 2014. There is a possibility that this lower future rate is due to increased future hidden unemployment (increased hopeless in job-seeking) reducing the amount of people who will search for jobs, in turn biasing unemployment downward. But it may not matter because the optimism the Fed is relaying could be playing a larger role, and the Fed knows this. We may begin to move away from economics and monetary theory when trying to measure and assess optimism and pessimism, but they are important considerations when thinking about how the Fed makes moves and channels decisions.

    Deciding whether the Fed should continue further quantitative easing or halt easing based on current data relating to the effectiveness of near-current policy (like ‘Operation Twist’) is difficult and could be irrelevant. Data trends are large, complicated, and easily misinterpreted. It’s good not to forget the “touchy-feely-stuff” like power of word-of-mouth and optimism. These variables are embedded somewhere in the regressions and although they’re difficult to measure and to predict, they may be severely important. There’s a possibility that the Fed should commit to decisions based on whatever makes them appear most credible and makes the majority of the public most optimistic.

    (1) http://www.bloomberg.com/news/2012-03-13/fed-says-labor-market-improves-leaves-policy-unchanged.html

  2. While the Fed’s recent Beige Book release in February showed improvements in all sectors of the economy, Bernanke has admitted the economy is in a “soft patch” (1). A soft patch is “a period of economic slowdown amid a larger trend of economic growth” (2). The plummeting prices of gold along with the rising prices in oil have created worry over how the Fed’s policy and Bernanke is right to express caution over of the uncertainty of future growth.
    Recent data points to decreased consumer loan demand and increased credit card debt. Without consumer expenditures, there can be little expected growth for the United States economy (3). Bernanke hopes another round of quantitative easing would loosen consumer wallets by increasing cash. This could be more harmful than hopeful. Due to the recent policy statements by the Fed to adhere to an inflation target of around 2%, increased money supply could skew inflation rates in the short-term, taking away credibility from the Fed, and its policies. Expectations of higher inflation can keep consumers from consuming or borrowing long term.
    The Fed’s should halt its plans for QE3. The current data is too conflicting, since the Beige Book and Bernanke’s testimonies before Congress yielded different messages. Instead, the Fed should continue to monitor and keep inflation in check, as per its targeting policy.

    1. http://www.forbes.com/sites/afontevecchia/2011/06/22/bernanke-admits-hes-clueless-on-economys-soft-patch/
    2. http://www.investopedia.com/terms/s/softpatch.asp#axzz1pZXcbci9
    3. http://www.forbes.com/sites/afontevecchia/2011/06/06/no-recovery-possible-while-u-s-consumer-continues-deleveraging/

  3. The Fed is probably going to implement QE3 in the coming time, unless the economy takes a sharper turn upwards. The economy is still very fragile. While some of the data like employment and currency markets seem like they are on the upward trend, we must not forget that it could not be long lasting. QE 3 is needed to provide an “insurance ease” from some of the issues that are still in our foresight and some data that could be skewed. For an example, while the GDP numbers for this quarter look promising (2.7%), it could be skewed by the effect of unseasonable weather in this quarter. Another example of why QE3 could be beneficial is that despite data that is moving toward full employment, we are still far off from that milestone (6.7 percent at end of 2014), to speed up the process and reduce involuntary and future structural unemployment we could implement the next round of QE. Another problem with “laying low” for the Fed is plain uncertainty. We still do not know the full effects of how the European debt crisis will hinder the U.S growth. With QE3, the easing gives of a cushion of liquidity that could help maintain our “escape velocity”. The inflation hawks obviously think that this QE round is unnecessary and are concerned with the growing prices we face at the pump. This concern can be contested by Capital Economist analysts because they argue “What’s more, even if the oil price does rise further, the most likely catalyst would be a supply shock due to the tensions with Iran that ultimately would dampen economic growth and result in lower inflation than otherwise.” They also added that gas prices are about to peak and the CPI will fall back down to 2 percent soon. With no inherent problems with inflation I see no reason to not engage in the next round of QE.

    http://www.cnbc.com/id/46757524
    http://blogs.wsj.com/marketbeat/2012/03/15/goldmans-hatzius-we-still-expect-fed-to-buy-bonds/
    http://www.bloomberg.com/news/2012-03-13/fed-says-labor-market-improves-leaves-policy-unchanged.html
    http://www.forbes.com/sites/afontevecchia/2012/03/12/expect-a-quiet-fed-meeting-but-500b-qe3-is-around-the-corner/
    http://www.bloomberg.com/news/2012-03-13/fed-says-labor-market-improves-leaves-policy-unchanged.html
    http://money.msn.com/top-stocks/post.aspx?post=47e6b4b5-b07d-4abe-a6d3-f1dad1594d9d

  4. I believe the Fed is going to need further easing. As Nomura’s analysts plainly point out “housing prices [are] still looking for a bottom, [there is] meager job growth, [there are] record-high oil prices, and [there is] the probable resurgence of the European sovereign debt crisis in the near future;” I don’t think the Fed can afford for the abrupt stopping of its quantitative easing policies (1 Forbes). Coupling these looming issues with Bill Gross’ comment here: “whenever central banks have stopped or paused their quantitative easing efforts, ‘stock prices have fallen and economies have slowed,'” it is doubly hard to think that the Fed won’t continue their quantitative easing (2 Yahoo). Additionally, when you consider that the Fed has even more dovish members now that it has had for previous announcements of quantitative easing, you must assume some form of quantitative easing will continue. But, I think the risk of inflation becomes even more of a threat with a potential QE3, especially if it is at the rate at which the Fed has implemented QE1 and QE2. Therefore, I assume QE3 is going to be more like QE2.5, an attempt to further bolster the economy and wean it off of the easy money. Even though the Fed is likely at or above its inflation target, it seems that current majority consensus is that further easing is still required to fight any possible additional contraction of the economy. That means watch out emerging markets, as any amount of QE3 will likely continue the devaluing of the dollar and give investors even more reason to hit the BRIC’s with hot capital. All in all, QE3 is likely right around the corner.

    (1) http://www.forbes.com/sites/afontevecchia/2012/03/12/expect-a-quiet-fed-meeting-but-500b-qe3-is-around-the-corner/
    (2) http://finance.yahoo.com/blogs/daily-ticker/pimco-bill-gross-qe3-inflation-muted-growth-way-115229488.html
    http://www.ibtimes.com/articles/315296/20120316/gold-price-consolidates-qe3-coming-by-june.htm

  5. For the Federal Reserve to consider QE3, they must believe that the economy is not recovering quickly enough. Because labor markets remain depressed, despite a couple of months of solid jobs growth, and housing prices continue to tread lower, there is speculation that the Fed could consider QE3. Critics opposing QE3 claim that additional monetary stimulus would cause greater inflation in the short run before coming back down. The FOMC specified a longer-run goal for inflation to be at the rate of 2 percent. The debate whether or not to use QE3 could be a function of previous quantitative easing implementations. The second round of quantitative easing involved the Federal Reserve reinvesting principal payments from agency debt and agency mortgage-backed securities that it had acquired in QE1 in longer-term Treasury securities As a result; the Fed expanded its balance sheet by $600 billion through the purchase of Treasury securities. The purpose was to reduce risk and ultimately lower interest rates. However, the quantitative easing did not actually have an impact on the real economy. The misunderstanding of the banking system made by the Fed was that the creation of reserves had major significance on lending. In hindsight, while the Fed lowered risk premiums, QE2 raised inflation expectations causing interest rates to actually rise. I believe that the Fed should not conduct further easing. Although unemployment rates have been falling from its peak of 10% in October 2009 to 9% in February 2011 to 8.3% today, the housing index has fallen considerably since the 2008 recession. However, data from FRED shows the housing index is almost as it was before the boom and bust in 2005-2009. The same can be argued with labor force and population being the same it is today as before the boom and bust. In conclusion, the Fed should not conduct QE3 because QE2 was a bust and the economic indicators mentioned above are consistent with what they were before 2005.

    http://www.forbes.com/sites/afontevecchia/2012/03/12/expect-a-quiet-fed-meeting-but-500b-qe3-is-around-the-corner/
    http://research.stlouisfed.org/publications/net/page11.pdf
    http://research.stlouisfed.org/fred2/series/USCSCOMHPISA?cid=32261

  6. First off, I believe Bernanke is holding his card close to his chest on this one. With the conflicting FOMC statements and his own statements during his testimony in front of congress, not only send mixed signals but also do not tell us all the facts. With the FMOC statement in February where for the first time in history the United States Federal Reserve has set an inflation target of 2% annual change. This unprecedented move by the Federal Reserve could have serious conflicts with its dual mandate system of full employment and stable prices. By setting an inflation target I think the fed is trying to set expectations on inflation to get a better picture of the US economy. Also with the FMOC statements on keeping interest rate relatively low till late 2014 could have the same effect. By setting expectations on interest rates and inflation they can control several variables to see where the US economy is actually going.

    One problem with trying to determine the strength of the US economy is that we are greatly dependent on oil. Oil prices tend to determine company profits, personal consumption, and spending habits of both. The most recent activity in the oil markets due to conflict in the Middle East maybe subsiding with oil dropping for the second day in a row and with the announcement that oil reserve maybe released sometime soon. This could help dampen fears of very high gas prices in the summer. Although with the closing of several oil refineries on the east coast such as Conoco Phillips and Sunoco Marcus Hook, the east coast could see temporary higher gas prices due to the lack of supply. Lately gold, a good indicator of inflation fears has been dropping in price since the FOMC statements and Bernanke’s eluding to maybe not another round of easing.

    Lastly the flight away from treasury securities and the rise of short-term yields could be more of a sign that stocks are just more attractive then bonds at the moment. This flight for a higher return from equities could just be a sign of financial markets coming back strong after several dismal years. The Dow Jones, S&P 500, and Nasdaq all posting multi year highs and returns that are just not there in the bond market, could be the reason we are seeing this change. I think seeing the end of operation twist will be the ultimate deciding factor of whether or not QE3 takes places. Whatever the decision I am sure that the fed has already begun to figure out its next move and how strong the US economy really is.

    http://www.reuters.com/article/2012/03/15/us-oil-reserves-idUSBRE82E0UM20120315

    http://www.businessweek.com/news/2012-03-13/treasuries-remain-lower-after-fed-says-u-dot-s-dot-employment-market-is-improving

  7. As the first quarter of 2012 comes to a close, we should start to get a better feel for inflation pressures. As companies will start to release first quarter earnings, these earnings reports may give us more detail into the prices producers are paying and where inflation pressures maybe building. This I believe is not the case though; as 2012 moves into high gear the pickup in the job market has become more pronounced. With acceleration in hiring and spending by companies, I do not see inflation being an issue for the producers in 2012. If companies are spending and hiring, their balance sheets must reflect the capital in order to do so. The growth in the job market also reflects this feeling when last month the American economy added 227,000 jobs. Although the unemployment rate may have remained unchanged this could be because of the return of some discouraged workers back to the labor force. Also along with the growth in the labor market household income over the past six months has rose on a monthly pace of .3 percent. With this steady growth in income we could start to see a rise in GDP growth that is pushed by an accelerating labor market and growth in house hold income.
    As for QE3, with banks balance sheets packed to the gills with excess reserves. We could see inflation pressures raise very quickly if they were to start to lend this money out. The amount of excess reserves which banks hold as part of their balance sheets has never before been this high. With banks scared to lend and consumer outstanding credit exploding as well, we could start to see inflation pressures starting to build. With a percent change in core PCE at the end of 2011 of 2.1%, this means consumers have 2.1% less purchasing power then they did in the third quarter of 2011. With this increase in core PCE which takes out volatile food and energy prices, which in the last month have begun to increase dramatically. Also with the department of energy reporting for the month of February American consumers used 2 % less gas then they had the previous month. With the exceptionally warm weather for this time of year we could start to see seasonally adjusted trends not making much sense. Only time will tell where the US economy is headed but for now I believe QE3 does not need to take place. With companies spending, the labor market creating jobs and household income on the rise, there is no need to jump the gun.

    http://www.cnbc.com/id/46819079
    http://bea.gov/iTable/iTable.cfm?ReqID=9&step=1

  8. According to all of the recent economic data I can find, I believe that the government should not implement another round of quantitative easing, yet. As of February 2012, the Leading Economic Index for the US increased 0.4% to 94.9 (out of a 2004 base value of 100), and more recently, consumer confidence has increased 9.3 points (1). The article in Bloomberg reports complimentary statistics stating that retail sales increased 1.1% in February, the Dow recently reached its highest average since 2007, and interest rates on Treasury notes are increasing (2). Richard Fisher, President of the Federal Reserve of Dallas, also does not think another round of QE is what the US economy needs right now. In his speech released on March 5, 2012, Fisher states that although the recent increase in oil prices has not yet been reflected in the CPI, that the underlying trend has been converging on the FOMC’s inflation target of 2%. Fisher continues by stating that the Federal Reserve already has over $1.6 trillion of U.S. Treasury securities, almost $848 billion in mortgage-backed securities on its balance sheet and that more than $1.5 trillion in excess reserves from banks is sitting with the fed (3). So, with almost $2 trillion dollars lying around unused (on which banks are only receiving 25 basis point of interest), why is the economy looking for another injection of money? I have to agree with Fisher that financial market operators have become hooked on the “monetary morphine” that was used during the “financial reconstructive surgery” performed in 2008. Even though this uptick in the economy hasn’t proven to be strong, the fed should see how the economy fairs in later quarters of 2012 before handing out more monetary morphine.

    (1) http://www.conference-board.org/
    (2) http://www.bloomberg.com/news/2012-03-13/fed-says-labor-market-improves-leaves-policy-unchanged.html
    (3) http://www.dallasfed.org/news/speeches/fisher/2012/fs120305.cfm

  9. I believe there is a strong possibility that the Fed could start a third round of quantitative easing relatively soon. Even though we have had strong employment numbers, retail sales and decent GDP growth over the last quarter, those numbers can be a little bit misleading. GDP growth was driven mostly by growth in inventories while retail sales and employment was largely affected by a nonexistent winter; and we have still yet to seen the effects of higher gasoline prices. [1] Also, the unemployment rate still has a significant amount of ways to go at above 8.3% before it reaches full employment. Bernanke sees a lot of headwinds facing the economy including higher energy prices, hard landing in China, and sovereign debt issues arising once more in Europe which could affect economic growth. The recent improvements in economic growth are fragile and with all of the possible downside risks facing the US economy, Bernanke sees a favorable risk reward tradeoff for additional quantitative easing. February inflation numbers came in lower than expected at 0.4% [1], which leaves room for the Fed to further stimulate the economy. Companies have become more profitable as they have slimmed down and focused on high margin businesses. The threat of inflation eating away companies’ margins I believe is relatively low given historic profitability. I also believe the market has priced in another round of asset purchases as interest rates on treasuries have remained relatively low during the past quarter as equities have rallied around 12% [2]. Usually when equities rise, so do interest rates. I believe the Fed will initiate another round of quantitative easing in an attempt to solidify and protect the fragile recovery from the growing downside risk present in the global economy.

    [1] http://online.wsj.com/mdc/public/page/2_3063-economicCalendar.html?mod=mdc_h_cmgrel
    [2] http://www.bloomberg.com/markets/

  10. I believe that the Fed will implement another round of quantitative easing. There are a few things that lead me to believe this. The “labor markets remain depressed, despite a couple of months of solid jobs growth, and housing prices continue to tread lower.” This might lead the Fed to do a round of easing to help insure that the “fragile recovery” stays “on track and hedge[s] itself ahead of fiscal headwinds and external shocks, according to Nomura’s fixed income research team.” “Bernanke has made clear he still believes housing markets are in the gutter, and that the Fed isn’t delivering on the employment side” (1). Also research has shown that “since 1947, when two-quarter annualized real GDP growth falls below 2 percent, recession follows within a year 48 percent of the time” (2). In the last quarter we had real GDP rise by 3 percent but in the previous 3 quarters it rose at only .4, 1.3 and 1.8 percent (3). Though we had a rise of 3 percent in real GDP last quarter, the “recent strength is probably due to the unusual warm weather and perhaps some seasonal adjustment distortions” (4). Due to the fact that unemployment is still high, housing prices getting lower, and the fact that real GDP growth is still low and the good quarter we just had might be due to outside factors I think that a third round of quantitative easing as insurance is pretty high. The Fed does quantitative easing by purchasing bank loans, mortgage-backed securities and U.S. Treasury notes from banks and gives them money in return. One reason they do this is to spur the banks that they bought the assets from to make more loans. They bought the Treasury notes to keep up demand for the notes that the government is auctioning off to pay for expansionary fiscal policy and to keep interest rates lower. “These low rates were critical to keeping mortgage rates low, as well. And that was important if the housing market was ever to revive.” (5)

    (1) http://www.forbes.com/sites/afontevecchia/2012/03/12/expect-a-quiet-fed-meeting-but-500b-qe3-is-around-the-corner/
    (2) http://blogs.reuters.com/james-pethokoukis/2011/08/02/more-evidence-u-s-economy-approaching-stall/
    (3) http://www.tradingeconomics.com/united-states/gdp-growth
    (4) http://blogs.wsj.com/marketbeat/2012/03/15/goldmans-hatzius-we-still-expect-fed-to-buy-bonds/
    (5) http://useconomy.about.com/od/glossary/g/Quantitative-Easing.htm

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