Dunkelberg: The Fed's Plan Doesn't Pass the Common Sense Test

William Dunkelberg, Economics Professor, Temple University
Monday, 1 Oct 2012 | 4:17 PM ET
United States Federal Reserve
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United States Federal Reserve

A few months ago, I wrote about what I called a “Johnny One Note” Board of Governors at the Federal Reserve, noting that one president had appointed nearly all of the seven Governors whose terms were set at 14 years in the Fed charter to insulate the Governors of the printing press from the pressures of current politics.

Most don’t serve a full term (academics typically leave after two years to preserve their faculty appointments), which means that new appointments are continually made to try to maintain a full complement of qualified, objective Board members with different perspectives to make monetary policy (if differences in views are not of value, then we only need one person to determine policy).

Of course all Presidents will make appointments of people of a similar political persuasion. Thus, our “Johnny One Note” Fed Board of Governors. (Read More: Bernanke Pushes Back: Fed Not Enabling Big Deficits)

The decision to undertake QE3, purchasing $40 billion of securities until employment improves enough to meet the Fed’s unspecified objective is certainly not “transparent” but more importantly, the Fed has no plausible explanation as to how buying another trillion in assets would improve employment. (Read More:Fed's Plosser: QE3 Won't Do Much for Growth)

Certainly the data suggest QE1 and QE2 have not done the job, $2 trillion added to the Fed’s balance sheet. So how will another half a trillion change this? The best story we get is that QE3 will inflate the nominal value of assets making people feel “wealthier” and inducing them to spend more. Empirical analysis suggest that, historically, perceived permanent increases in wealth did increase spending a bit, but that basically applied to house values, and that relationship is likely on hold today. Consumers don’t regard changes in stock prices as “permanent” and so this was less impactful. I guess we do know that the Fed is now targeting the stock market with its policies. (Read More:Fed Virtually Funding the Entire US Deficit: Lindsey.)

“We’re looking for ongoing, sustained improvement in the labor market.” “There’s not a specific number we have in mind. What we’ve seen in the last six months isn’t it.” (Bernanke press conference, Sept. 13)

Interest rates have been at record low levels for a long time now. There isn’t a pool of mortgage demand just waiting for another 25 basis points in rate reductions to buy a house, and who hasn’t refinanced already that is eligible to do so? Do small business owners have a huge pool of deferred spending and hiring that will suddenly be unlocked by a slightly lower interest rate? It is hard to believe that the Fed really believes this is the case, yet they have proceeded with QE3 with all its attendant risks, including raising even further the uncertainty about the future for inflation and asset bubbles.

Lost in all of this is the saver. Every dollar a debtor saves in a refinance or a default is a dollar lost by a saver. Savers are being punished. Interest income is down over $400 billion from 2008. If you want a safe investment with some yield, you can lend the government $1000 for 10 years and get 1.6%. Of course, if interest rates double (that would be 3.2%, hardly a high rate historically) and you wanted to sell your bond, it would fetch only $500, a 50% loss of your money. Or, you can wait out the full 10 years earning a sub-par return. In 2007, to get $1000 in interest income, you could invest $22,000 at the then prevailing money market interest rate of 4.5%. To get $1000 in income today, you would have to invest over $3 million (earning about 5 basis points, today’s rates)! The long term damage being done by current Fed policy will be imposed on tens of millions of consumer victims over a decade or more. (Read More:Fed to Ease Until Jobless Rate Falls Below 7%: Evans.)

When economic policy can’t be understood on a common sense basis, uncertainty rises and this inhibits the fundamental tendency of the private sector to recover and restore economic growth. Only about one in ten consumers think government is doing a good job, and that can’t be good for the economy.

William Dunkelberg is an Economic Strategist, Boenning & Scattergood and Chief Economist, National Federation of Independent Business.