ECON430-Topic #3: QE2 and the Elections

The elections have passed, and the House of Representatives will now be securely controlled by the Republicans while the Senate will continue to be narrowly controlled by the Democrats. These changes might not seem important to monetary policy, but the Republicans have taken control of the house, and regained some power in the Senate under the banner of fiscal austerity. A split chamber might lead to gridlock, but I would like you to consider what fiscal austerity might mean for monetary policy.

Alan Greenspan, former Chairman of the Federal Reserve Board of Governors recently was quoted as saying extensions of the Bush era tax cuts could be “disastrous” if not offset by spending cuts elsewhere. Back in 2003, Greenspan warned that these same tax cuts would lead to large deficits. This is the same Alan Greenspan that has been vilified for leaving interest rates “too low for too long” while heading the Fed, and who supported tax cuts back in 2001 (also notice how Greenspan incorrectly predicted that the recession would not occur in 2001).

Ben Bernanke, the current Chairman of the Board of Governors, recently was quoted as saying:

“it is crucially important that we put U.S. fiscal policy on a sustainable path.”

The importance of fiscal austerity has a role in the effectiveness of monetary policy. I would like you to consider the possibility that the Fed is conducting QE2 under the expectation that these measures will take some time to implement, and that there is now a very slim possibility of further fiscal stimulus. If the legislature extends the tax cuts for another two years or more, slashes spending, and trims aid to states, monetary stimulus may be the only tool left in the arsenal to keep our economy from encountering another recession.

QE2 has been supported by some economists, and derided by others. Many think there will be little to no impact from the Fed’s move, in part because of the prospect of fiscal austerity.

Questions you might try to answer:

  • Do you believe that QE2 is the right thing to do considering the political environment?
  • Given that the new Speaker of the House is heavily supported by the financial services industry, do you believe that expected “de-funding” of financial regulation would allow for better economic growth?
  • How do fiscal austerity measures impact the Fed’s ability to conduct effective monetary policy in this environment where short-term rates are already at the zero-bound.

Remember to keep a monetary policy angle to your comments. Also, I’m not sure where it comes from, but please refer to the “Federal Reserve” as the Fed, not the FED.

21 thoughts on “ECON430-Topic #3: QE2 and the Elections”

  1. In my opinion the recent shift of party power will lead to a gridlock in Washington. However, the possibility of fiscal austerity has arisen. Fiscal austerity is defined as a policy of cutting deficits, lowering spending, and is often coupled with raising taxes in order to pay taxes. Austerity usually signals that a government cannot honor its debts liabilities. If this is the case than an austerity approach would restrict the Fed’s ability to conduct effective monetary policy. In other words the implementation of QE2 would prove to be ineffective. This is so because the injection of more cash into the system would further drop the already extremely low interest rate even further. This would further depreciate the dollar and not help with the deficit.
    As far as defunding financial regulation, I feel that this would lead to further economic growth. This is so because it would allow for individuals and companies more freedom to do as they please with their money. This freedom would lead to more spending and growth in the financial sector that would lead to overall economic growth.

  2. Perhaps the Republicans gaining back the House is a negative result. Gridlock may or may not ensue. But one of the most important outcomes of the recent elections may be a new Speaker of the House who is heavily supported by the financial services industry. This move will cut more spending and cause a “de-funding” of financial regulation. With the House now in control of the GOP the Consumer Financial Protection Bureau (CFPB), created by the Dodd-Frank reform bill, may be the first program cut with so many doubters [1]. Obviously, there is a strong sentiment that the Obama Wall Street Bill is not favored by Republicans.

    However, with the Republicans pushing so hard for “de-funding” the question comes into play of will a regulatory system even work? Already agencies are scraping together funds to institute the reforms of the Dodd-Frank bill. With fewer funds available for the regulatory system, less talented individuals will be attracted to those positions and thus we could end up in a situation we found ourselves in two years ago [2]. Perhaps taking a hit now and funding some of these regulatory agencies may be preventative measures in the long-run to save ourselves from enduring another situation like one that we saw in 2008 and ultimately help the economy.


  3. I do not think that QE2 will have a significant effect on the US economy. QE2 is meant to incentivize investment in other areas other than long term bonds but I don’t think it’s enough to have an effect on the economy. It’s possible that they will be able to promote stocks and things like that but that will have no direct effect on employment which is a serious issue right now. On top of that, I don’t really see this having much of an effect on inflation, especially since Bernanke has claimed to not want it to bring inflation above normal levels. I agree with Paul Krugman that if monetary policy is going to work, the Fed needs to drastically change expectations and in order to do this, Bernanke cannot be timid about his policy. He must push forward boldly and clearly communicate that he expects much more drastic changes in the economy.

  4. Fiscal austerity refers directly to the government budget constraint where: G + TP = T + MC + BS. When austerity measures are taken to decrease budget deficit we will see increases to the right side of this equation since at all times, except during the Clinton administration, G + TP > T + MC + BS. The Fed can utilize unconventional monetary policy, beyond conventional tools such as open market operations, to help aid the government in balancing this deficit. Take for example QE2 – the whole theory behind QE2 is for the Fed to inject the economy with money by buying government bonds with 5-7 year durations. Ideally, this should lower interest rates and promote borrowing (amongst other things). Therefore, with the help of the Fed, the government in increasing MS. By comparison, lets examine bond sales (BS). We know that the government can issue debt at almost any time and we also know that the Fed can step in and buy this debt, similar to QE2, in unlimited amounts. Hence, if the government want to balance the deficit by increasing BS the Fed can help them do this through unconventional tools of monetary policy. All in all, as long as the government doesn’t keep increasing G or TP at unsustainable rates, the Fed’s monetary policy can be used to help effectively balance the budget, however, that is not their motive right now.

  5. The most important thing about the recent elections is the high probability of deadlock. Given the rhetoric of the election, not only is QE2 necessary, it’s the ONLY thing that can be done. The chances of getting any meaningful spending cuts are as remote as any massive second stimulus. Given the continued low consumer confidence(2) and the lethargic nature of unemployment there is no other source of needed stimuli. This is especially troubling considering the “balance sheet” nature of this recession(1) makes it difficult for banks to lend within their capital constraints, while consumers shrink their debt in the face of lost credit and evaporated wealth(1).
    Another facet of the Republicans winning the house is the probability of deregulation. While less stringent regulation would increase growth in the financial services sector; the vast majority (the bottom 90%) of the population don’t realize any income from this growth(3). To them wages haven’t risen, their perception of wealth is still in the toilet, the financial industry employees more educated workers and most importantly this deregulation would allow increased fees and unjust lending practices that disproportionately effect the poor & uneducated (overdraft charge, late fee, late fee on a late fee etc. doesn’t endear one to the bank).
    The final point I wish to make is that this is the worst possible time for fiscal austerity. While I wholeheartedly agree that the status quo of borrowing today to fund current (and hugely wasteful) government expenditures is folly. However, there are three ways out of our current debt problem; higher taxes (or inflation), substantially lower spending, or increased growth. Since the first two are ruled out by the congressional deadlock, the 3rd is still viable. However given the historic lows the Fed has driven interest rates there is no better time for a productivity improving works project funded with debt. Provided there is more oversight then the “shovel ready” projects of the first stimulus(4) this plan would lower unemployment and hopefully increase our GDP growth. I hope I’m a pessimist but I see this is as likely as 33 black 3 times in a row (38^3=54,872/1).

  6. Now that the Reds officially control the House and the Blues kept control of the senate, Congress will have a tough time passing any sort of legislation. The looming debate over the potential renewal of the Bush tax cuts as well the talk of extending unemployment benefits present significant challenges for Congress. Also, the federal government’s budget is still incomplete and is operating under a “continuing resolution” which runs out at the end of the year [1]. The GOP ran on and gained a lot of steam by pushing the issue of fiscal austerity. Though this has a direct impact on fiscal policy, it does have auxiliary effects regarding monetary policy. The split chamber as well as the growing push for fiscal austerity have created great uncertainty in today’s economy.

    Because of this uncertainty, companies choose to hold large amounts of cash. Companies are holding more cash on their balance sheets than ever before on record [2]. Because they are getting minimal returns on their money, they choose to hoard cash in order to be insulated from any negative shocks. These companies are hoarding cash in order to maintain power in their industries. They will use this cash to make acquisitions or buy back stocks in order to maintain stability and stock price in the business. Therefore, QE2 will be minimally effective at best because it will drive the interest rates even closer to zero, but companies aren’t borrowing to begin with. Yes, it will inflate away some of the value of this cash, but CEO’s will take power over return on money every time [3]. QE2 will be an ineffective attempt to stimulate the growth


  7. The United States is in a precarious economic position. Over the past several years, the U.S has run up an extensive current account deficit in order to finance increased consumption. Also, due to the recent economic crisis, the Fed is facing high unemployment levels. With Republicans retaking some control of Congress, a reduction in fiscal spending will become a reality on Capitol Hill. Fiscal austerity has a contractionary effect on output, employment, consumption, and investment. Typically, to lessen the impact of the negative effects, fiscal austerity is paired with a decrease in interest rates by the central bank. Unfortunately, since the Fed has driven interest rates to near zero levels, the reduction in fiscal spending will have a more significant negative effect on output in the short run. With fiscal policy now unable to stimulate the economy, the U.S will rely more on monetary policy to help with the country’s recovery. With interest rates already at record lows, monetary policy will have to escalate inflation expectations in order to increase spending and employment. This means that QE2 is coming at a good time for the U.S. By pumping six billion dollars into the economy, inflationary expectations should rise and increase short term spending. However, there has been debate over whether or not QE2 will have any effect. The overall impact that fiscal austerity will have on monetary policy is that the Fed can no longer maintain its goal of enforcing low inflation while trying to stimulate the economic recovery.

  8. With the House being controlled by the Republicans, and the Senate by the Democrats, it’s going to be extremely hard to pass any legislation. Even though quantitative easing will not have a large effect on the economy, $600 billion over the next several months will help keep interest rates down, which keeps borrowing costs down, and will lead to a small amount of inflation. The Fed has been disappointed with the slow recovery of unemployment and inflation, so they chose to step in and try and help a little bit. However, fiscal austerity makes it difficult for the economy to recover, and may even cause it to contract due to the reduced spending. If we continue to pay for these programs, we would be borrowing on borrowed money, which would increase the deficit even further. Since interest rates are already at near zero levels, fiscal austerity would drive them down even more. For fiscal austerity to work, taxes will need to increase. Right now the Bush tax cuts are being debated whether or not they should be extended. The Republican argument is that tax cuts pay for themselves by generating revenue from the people who receive them. Since a lot of people are still trying to recover from the financial crisis, I don’t believe that tax cuts are the best option.

    From 2:55-4:47

  9. Right now it seems that the government and economists are trying to fix several problems at once. We are hoping that QE2 will help the economy recover by increasing government spending. Yet, we have other people who are focused on the deficit and believe that lowering it should be our number one priority. I believe that the focusing on the deficit (as the top priority) is wasted effort at this time. Now in my opinion I see that we should first get ourselves out of this economic stagnation and then during our next expansionary time (hopefully sooner than later), decrease the deficit. In Keynesian economics, during a recession you are typically not interested in the deficit spending because the repayment was during the expansionary period. I understand that we must keep an eye on the deficit but it should not be our main concern; but adding another 10% to the deficit now may not be that bad of an idea in the long run. With a main focus on the demand of the economy we can hopefully find a better solution. This solution may just be time; time can allow the markets to clear and allow the invisible hand to fix it.

  10. While considering the new political shift after the recent midterm elections, would it have made more sense for the Fed to wait to implement QE2? Perhaps they should have started the easing process before these elections? Regardless of the timing of the elections, the Fed and many economic journal writers as well as economists across the media have been expecting this round of QE2 to be right around the corner. It is because of this expectation that I think the Fed does not have much of a choice but to continue on with QE2. After all, the end goal of any Fed program following a recession is to stimulate the economy; the end goal of quantitative easing is to increase the money supply by increasing the excess reserves in the banking system. This will fail as an overall Fed practice if banks hoard cash because they cannot find enough worthwhile loans to enter into. However, with the expectation that more reserves are coming, banks can start to draw up new economic forecasts for the future in our given economic environment as well as potentially set up a new risk tolerance when entering into loans. The overall timing of QE2 and the midterm elections is merely seen because of the timeline of the financial crisis up until now. The Fed is still scrambling to pull us out of our current financial rut and congressional elections happen every 2 years, so what. The only real issue seen with the timing of these elections is politicians who think and act like they know what they are talking about when it comes to quantitative easing and the banking world. For example, someone like Sarah Palin who went as far as to tell Ben Bernanke to “cease and desist” is only a problem because she has people who follow her and listen. She specifically cited the rise grocery prices as her reason for being concerned with further inflation, but the numbers flat out disagree with her. Not only does the CPI measure of food and beverages for the first 3 quarters this year disagree with her, but they show the lowest annual average inflation since the stat was recorded in 1968 at 0.6% (WSJ).

  11. I do not believe that the Fed’s policy of QE will be effective in the current political system. Republicans are going to push for an increase in tax that will hopefully lead to increase spending. However, one negative side affect caused by QE is the possibility of rising commodity prices [1]. Ben Bernanke stated that he has already engaged in buying back debt from the U.S. Treasury [2]. This year the U.S. has seen an all time high for oil, gold, as well as cotton.

    An article on CNBC, stated that cotton prices have a reached an all time high since the Civil war. “It’s at pricing levels not seen since just after the Civil War, spiking about 80 percent since the early summer” [3]. If commodity prices are rising due to the actions of the Fed, consumers are going to be less likely to buy as much commodity goods. If the tax cuts are passed to increase consumer spending this might be offset by the rise of commodity prices. Therefore, these two actions may cause a neutral effect. Many people like Joseph Stiglitz believe that QE will not work because of political spending [4]. The major problem that our economy faces is that Politicians make decisions not economists.


  12. I believe QE2 will have a significant impact on the U.S economy, and due to contagion will spread throughout the world, again. I my opinion we can completely disregard the notion that U.S government defaulting on its debt is a black-swan event; the chances of default are increasing because of the Treasury’s ‘borrow-to-borrow’ horseplay. QE2 essentially is a partial monetization of our nation’s debt, more over QE2 is represents a partial default on our nation’s debt. A blogger for the Economist explained the monetizing debt as “It is as if you tried to pay your supermarket bill with Monopoly money, on the grounds that it was the only paper money you could find in the house.” [1] Along with the republicans taking over the house and probably extending the tax cuts, paying our nation’s debt with monopoly money is by no means sustainable. In addition, the US has been downgraded by China’s credit rating agency (Because of QE2), which means that our cost of borrowing from the Chinese will go up in the future [2]. In conclusion, QE2 was an inevitable move that will have inevitable consequences such as default, austerity, and bubbles (Investors could flood money somewhere else in search of yield).

  13. In my opinion, because Republicans have taken control of the House of Representatives, it is more unlikely that the needed policies/changes will be implemented. The reason for this is not because Republicans are bad for the economy or don’t know what they are doing, but simply that we have a Democratic President and a Senate that is barely controlled by the Democrats. This means that anything either side may push for is unlikely to pass simply because the other side won’t allow it. After reading the articles above, I think that QE2 will have some benefit. However, it also seems that while it may have some benefit, it will not be great enough to lower the unemployment rate or push interest rates back up (which is one of the things needed). Although it is unlikely, I think that the tax cuts have to be throw out so that our government can have more “real” money to spend/stimulate the economy with. Continuing to just pump money into the economy is likely to have longterm negative effects such as devaluing our currency even more.

  14. I think that now is certainly the wrong time for Congress to begin a fiscal austerity program. Greenspan predicts that high unemployment may be a lagging problem that will take time to recover from. For that reason I think the government should use all the tools at its disposal to try and jump-start economic activity and creation of jobs. That means that they should use both expansionary fiscal and monetary policy. In this current situation I think inflationary fears and concerns about long-term debt accumulation should be secondary to the creation of growth and jobs. Many predictions say that the recent QE will only have marginal effects, but I think that even if the effects are marginal then they are better than nothing. In terms of fiscal austerity and the tightening of Wall Street regulation, I agree with many people that a Republican House will not allow for a serious overhaul of the system, which might be a good thing in the short-run. I think now is the time for the government to focus on the short-run issues like employment and growth, and worry about inflation and debt once we have fully recovered from this recent recession.

  15. The first prompt to think about, “Do you believe that QE2 is the right thing to do considering the political environment?” is interesting. Ideally, the central bank wouldn’t implement policy to reach a political end. But, since the FOMC didn’t announce everything until November 3rd [1], I am not inclined to think that there is foul play involved. Yet, I think that the Fed’s independence will be tested like never before in the coming years. The United States will have to get its fiscal house in order. The GSEs are giant money pits. A large part of our population will be retiring here in the next decade, and a smaller workforce will have to support a government with even greater demands for tax revenues. Additionally, the cost of financing its debt will eventually have to rise.

    With all these fiscal pressures, it will be tempting for the central bank to monetize the debt. Even though Bernanke has already said under oath that he will not do such a thing [2]. In the eyes of some, he has already broken this promise with QE1. While I suppose we could say it isn’t debt monetization because the US is still having successful public auctions, it certainly was a massive creation of liquidity, even if it isn’t showing up as inflation (or is it?).

    It doesn’t matter if Republicans or Democrats control Congress. They are both parties of big government, in one way or another. Republicans won’t cut defense or entitlement spending. The Democrats are hesitant to raise taxes on those who elected them, and they are similarly hesitant to cut entitlement spending and spending/subsidies for social programs.

    Chairman Bernanke will ultimately have to have to refuse pressures for debt monetization. But before this, he will have to refuse demands for further non-traditional monetary stimulus if large amounts of people continue to be unemployed. The Fed is only supposed to reduce cyclical unemployment, and it is a very good possibility that the Natural Rate in the United States is higher than 5.5 percent.



  16. Currently, the Fed faces an astronomical problem with interest rates at an all-time low in history and the economy not in the most robust position. The Fed has come up with the solution to buy treasury bonds from the market to increase the amount of liquidity, which in turn decreases the interest rates. However, the Fed wants to use Fiscal austerity to promote economic growth. The goal of Fiscal austerity is to increase private spending which lowers the interest rate. The lower interest rates cause the exchange rate to drop, increasing the demand of foreigners of domestic goods. Since the interest rate is at such a low, Fiscal austerity does not seem to be the answer. The United States’ interest rates do not have room to decrease any more. It is also clear that the interest rate of the United States does not have much of an effect on the exchange rate, since the dollar is a safety asset in many countries world wide. The Fed needs to concentrate on increasing output; more conducive methods would be for the government to use fiscal policy and motivate people to work by lowering the unemployment benefits in order to spurn economic growth.

  17. Major problem in US economy are high unemployment rate which is about 8~9% and QE2 will not solve this high unemplyment rate problem or increasing aggregate demand. It will lower long-term interest rate and asset price which is good for stock market but not hughly impacted on US economy. Now republican take a power on house which mean they would not allow to pass any tax low. And it will make trouble to increasing money supply. so “de-funding” of financial regulation can improve economic growth but it is too risky and republican will not allow to make it happen. Fiscal austerity will have impact on monetary policy which the Fed tried to maintain low inflation rate to improve US economy

  18. With the Republicans now in control of the house, the possibility of fiscal austerity with the due to the potential of cutting spending, cutting funding of programs, and keeping the Bush tax cuts, is likely to do the opposite of what I and many other believe is the solution right now. QE2 is unlikely to have much effect as the previous stimulus didn’t increase the money supply and showed negligible changes to the economy. The benefits of another round look to be marginal as consumers aren’t worried about their liquidity or interest rates, as they are already near zero, but the years of unwinding credit and the uncertainty that comes along with further high profile monetary policy. I assume that the expected defunding of financial regulation will not spur economic growth for most Americans. I do believe that it will only contribute to the problem of deregulation in financial industries, as regulators already have a tough time enforcing the multiple thousands of pages of tax code already on the record, and it is supposedly only going to get worse, meaning an increase in what is the equivalent of lost revenues.

  19. I feel that QE2 will have a small but positive effect on the U.S. economy. It has the potential to combat possible deflation and stimulate consumer spending. I agree with Bernanke’s wealth effect in which the rise in value of household’s stock portfolios may induce consumer spending. Martin Feldstein stated that the QE2 is, “a dangerous gamble with only a small potential upside benefit and substantial risks of creating asset bubbles.” [1] Perhaps a small bubble in the stock market would be desirable since it would cause consumers to feel wealthier and spend more. In the current state of the economy; how large of an equity bubble could a $600 billion injection really inflate? Devaluing the dollar would make exports more attractive and could force the U.S. to be more dependent on domestic products as imports are more expensive. This should have a positive effect on GDP. I am concerned that open market purchases will drive down the already near zero interest rates, however raising inflationary expectations may cause rates to rise. Although I am against high government deficits, now is not the time for fiscal austerity. I agree with AFL-CIO president Richard Trumka, “Especially in these economic times, it is unconscionable to be proposing cuts to the critical economic lifelines for working people, Social security, and Medicare.” [2] The priority is to bring the economy to recovery. We can worry about the massive deficit after this mess is over.



  20. In this environment of high unemployment and highly liquid banks, tax breaks and low interest rates are not the best ways to stimulate the economy. Government spending on infrastructure would be ideal to stimulate job growth and investment. However with the incoming Republican run house, this option is unlikely to happen unless the leaving democratic house passes an increase to fiscal spending. If this does not occur and unemployment remains high, I would be willing bet the incoming Republican house would pass a fiscal policy measure probably through further tax reductions or even an increase in government expenditures in a year when their political rhetoric has been forgotten or ignored by the public.
    As for the Fed, I believe they are doing the best given the current environment. QE2 is set to mostly buy up 10-year bonds and use only 4% of the total expenditure to buy longer term debt. While not ideal, this has the best chance of any Fed option to reduce interest rates for home mortgages and general long term debt and maybe generate more lending. In addition this also leaves the 30 year bond as an unbiased indicator for inflation down the road. Right now the 30 year bond interest rate is rising due to general fear of inflation(1). Once these fears dissipate, I am certain we will see a fall in the long term interest rates in American especially with Ireland, Portugal, and Greece continuing to raise real doubts and interest rates on the Euro(2).

  21. Possibly the greatest positive impact of QE2 will be from the likely weakening of the dollar, which should help improve our trade deficit and keep jobs here. From this perspective it could help unemployment, unless other nations retaliate. To the extent that the yuan may be pegged to the dollar, this retaliation could be automatic. The second significant benefit I foresee is the devaluation of current US debt, which reduces the real cost of debt payments. This can obviously free up room in the federal budget, but its impact on private markets is more mixed. Companies and individuals will have an easier time repaying debts, but banks and other financial institutions, many of which are already struggling, will be taking an effective loss if inflation is greater than expected.
    I will also respond to a part of many previous comments, which mention an inability of the federal government to enact fiscal policy as a negative outcome of the recent election and current political climate. When coupled with the fact that interest rates have already hit the floor, it could mean that government ability to interfere with the economy will be sharply restricted. Personally, I believe that this will ultimately be a strong positive economically, as will legislative gridlock if it occurs. One of the most damaging factors to the economy is uncertainty. Over the last few years, the only thing business has been sure of is that the government will be doing something, probably many somethings, and that these somethings will be massive and have many impacts both foreseen and unforeseen. I believe that this has been an enormous negative factor. If for any reason businesses become confidant that there will be very little more government intervention, it will have at least two enormously positive impacts. First, risky activity taken with the assurance that a safety net exists may decrease, and second, corporations and investors that have been waiting to see how the business world will be changed by new laws or federal meddling can stop sitting on their funds (or credit based ability to acquire funds), and begin creating new economic activity.

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