El-Erian: Why Fed Is Unlikely to Have Third Round of Easing
Today’s data releases confirm that the US economy has undoubtedly hit another soft patch.
It is not the only one.
Other economies are also slowing or contracting—some as a result of budget austerity (such as the UK and the struggling European peripheral economies) and others because they are tapping their monetary policy brakes to counter mounting inflationary pressures (China and other emerging economies).
With such broad-based economic slowing, and with unemployment stuck at very high levelsand becoming more structural (and therefore protracted) in nature, market participants are asking whether the US authorities will again try to turbo-charge the economy. And with additional fiscal stimulus off the table due to deficit and debt concerns, the spotlight is fully on the Fed’s reaction function.
So, will there be a QE3 program—i.e., another round of asset purchases by the Fed that push valuations higher, make people feel wealthier and, thus, get them to spend on goods and services?
Quite a few people are drawing comfort from a very recent precedent. After all, it is only last year that a significant economic weakening in the second quarter (including talk of a double dip) led both to QE2 and a fiscal stimulus jolt.
Notwithstanding the historical parallel, I suspect that it is very unlikely that there will be a QE3. This view is based on an assessment of economic, political and international factors.
As Chairman Bernanke noted in his August Jackson Hole speech, and reiterated in his first press conference a few weeks ago, policy measures should be judged in terms of the expected balance of benefits, costs and risks.
I suspect that there is now broad agreement that, in the case of QE3, this balance has shifted: lowering the potential gains and increasing the probability of collateral damage and adverse unintended consequences.
It is also clear that, in its attempt to deliver “good” asset price inflation (e.g., higher equity prices), the Fed also got “bad” inflation. The latter, which essentially took the form of higher commodity prices, is stagflationary in that it imposes an inflationary tax on both production and consumption—thus countering the objective of QE2.
Politics also plays a complicating role. With the Fed’s balance sheet having already ballooned, there is growing unease in Washington about an unelected group of officials being so able to implement de facto fiscal measures with few checks and balances. I suspect that Fed officials realize this, and will likely resist further steps that would significantly erode their operational autonomy.
Finally, there is the international angle.
With structural impairments limiting the efficient absorption of stimulus in the US, liquidity injections lead to surges in capital flows to other countries. In addition to weakening the dollar, such surges complicate economic management in the rest of the world. They fuel inflation and credit bubbles, and force countries to counter with monetary policy tightening.
As a result, the global economy becomes like a car that is being driven with one foot on the accelerator and the other on the brake!
Put all this together and the conclusion is clear: It is unlikely that there will be a QE3; and if there is, more time will be spent dealing with the costs and risks, as opposed to the benefits.