Dunkelberg: More Fed Will Not Help the 'Real Economy'

Traders work in the ten-year U.S. Treasury Note options pit at the Chicago Board of Trade in Chicago, Illinois, U.S.
Daniel Acker | Bloomberg | Getty Images
Traders work in the ten-year U.S. Treasury Note options pit at the Chicago Board of Trade in Chicago, Illinois, U.S.

The debate over “QE3” \(Learn more\) seems to revolve primarily over whether or not more quantitative easing will have any impact on employment, the big “miss” on the Fed’s twin objectives.

Given that we have population growth of about 1% a year and that these new folk spend money, eat food and live somewhere, one might expect GDP (Learn more) to grow by roughly 1% as a result (a benefit not available to Europe and Japan). Any growth beyond that is a result of economic activity financed by growth in real income (or debt financed spending as was the case in the housing boom).

With trend growth of 3%, subtracting 1% population growth suggests that a normal economy would be adding 2% to growth that is produced by a rising headcount. We appear to be a percentage point below trend and more than that below what would be expected in a recover period (1983 GDP growth was 7%). So, $2 trillion in QE hasn’t produced the needed growth. Some argue “it wasn’t big enough”, others argue that the real economy will not respond to more liquidity, which will not be used until prospects for a return on real investment and hiring improve.

Financial markets like the QE3 idea of course, since even miniscule reductions in interest rates produce gains on the massive trading portfolios of the TBTF (too big to fail) banks. And equity markets also respond, though this may have reached its peak.

In 2010, markets produced double digit gains after Jackson Hole, but only half as much after the 2011 Jackson Hole meeting. If half again applies, gains will be in the very low single digits, not strong enough to overcome other news that might have an independent impact on markets (positive or negative). At some point, the Fed’s balance sheet will become terrorizingly large (if not already so). The Treasury will borrow a trillion dollars, the Fed will buy the equivalent of, say, 60% of that in existing Treasury bonds ( that’s the FOMC decision on QE, it is illegal for the Fed to buy directly from the Treasury), the Fed will collect interest on that debt from the Treasury, subtract its operating expenses and give the balance back to the Treasury.

At a recent gathering of economists in Maine (politics unknown), over 60% expected QE3 and 2/3rds of them looked for $500 billion or more in purchases (Treasury bonds or mortgage securities). This would take the Fed’s balance sheet toward $3.5 trillion with, likely, an equal increase in excess reserves unless this $500 billion suddenly precipitated the borrowing and spending the Fed is wishing for.

This is not likely.

Interest rates are at record low levels and have been there for some time. There is no pool of unsatisfied housing and investment demand just waiting for another quarter point decline in rates. Consumers don’t understand QE anyway. Uncertainty about job prospects, about sales prospects, about Europe and China, about government policies all make borrowing and investing in anything a risky venture, especially with a 50/50 toss up on the election that offers two very different policy paths.

Bottom line, QE3 will not help the real economy but will make the Fed’s “unwinding” job much more difficult.

William Dunkelberg, Chairman, Liberty Bell Bank, Chief Economist, NFIB, Economic Strategist, Boenning & Scattergood.