Has the Fed Run Out of Gifts to Give?
The taper has finally come, and if you ask economists, that means the end is nigh for quantitative easing. A Bloomberg survey of 41 economists found that the expectation is for seven incremental reductions in the rate of asset purchases over the next seven meetings of the Federal Open Market Committee.
This would wrap purchases up by December 2014 and leave the Federal Reserve with a $4.4 trillion balance sheet, according to economist estimates. Total asset purchases under QE3 are expected to hit about about $1.59 trillion, with $800 billion in mortgage bonds and $789 billion in Treasuries.
Monetary pundits have been busy trying to figure out if the taper was announced with a hawkish or dovish tone, but this is a somewhat superficial consideration. As a group, Fed policymakers lean dovish, but the taper strategy evolved from a place of analysis, not whim. The data say what the data say, and only Eric Rosengren, president of the Boston Fed Bank and a pretty hardcore dove, voted against the decision, interpreting labor market data as still too weak and the stability of economic growth still too unclear.
The other policymakers, though, appear to believe that the economy is, in fact, improving. Fed speak has evolved over the past few months and, as of the December meeting, policymakers determined that “economic activity is expanding at a moderate pace.” The crisis is over, and it’s time to take the training wheels off.
Here’s one reason why: The effectiveness of Fed policy has diminished. Monetary stimulus has evolved from being the medicine that helped financial markets and the broader economy get through the crisis to a drug. It now appears to service an unproductive addiction to easy money more than the favorable dynamic of job creation, rising income, and increased spending that Fed Vice Chair Janet Yellen talked about in her recent testimony before the Senate Banking Committee.
The ability of monetary policy to improve long-term labor market conditions has often been called into question. During a testimony in May, the chair of the Joint Economic Committee, Congressman Kevin Brady (R-Texas), asked Fed Chair Ben Bernanke: “My worry is that the Fed doesn’t have the prescription for what ails our economy. A year ago, the Fed said that it wouldn’t set an employment target rate because it’s generally affected by non-monetary factors. But you’re unwinding the QE based on the employment areas that you have the least control of. What do we make of that?”
Bernanke’s response pretty much confirmed Brady’s concern. “What we are trying to address here is the short-run cyclical gap,” he said. “We are seeing the economy operating at a level below what it is capable of operating at, and many people out of work who normally would have work, and monetary policy can help to put people back to work in the short run.”
Risks about running quantitative easing too long were voiced early on in the program’s history, and it was asked then what would happen when the Fed ran out of ammo. Ongoing QE stimulates the economy, but it also fosters risks. One of these risks — and one reason why the hawks are happy to see a taper — is inflation.
At a certain point, QE is no longer worth it, and running the monetary pump for too long on too high can begin to backfire. The Fed has made no secret of its thoughts on fiscal policy — which have broadly been contractionary, counteracting many recovery efforts — and the central bank may simply no longer be able to fight the tide. The Fed is running out of ammo.