We Were Right: QE Can't Cure Our Economy
Some in the press have inquired about the November 2010 letter urging the Federal Reserve not to undertake a second round of quantitative easing. The letter, directed to Federal Reserve Chairman Ben Bernanke, was signed by 23 economists
, including Columbia University Business School Professor Charles Calomiris, a member of the Shadow Open Market Committee; Manhattan Institute Senior Fellow Nicole Gelinas; Cliff Asness of AQR Capital; and Professor Michael J. Boskin of Stanford University. They wrote to the Chairman:
“We subscribe to your statement in the Washington Post on November 4 that “the Federal Reserve cannot solve all the economy’s problems on its own.” In this case, we think improvements in tax, spending and regulatory policies must take precedence in a national growth program, not further monetary stimulus.”
A few years and trillion dollars of quantitative easing later, the position that a Fed-managed recovery will be subpar is supported by the evidence. It is important to compare this recovery, which began in June 2009, with the recoveries that commenced November, 2001, March, 1991, and November, 1982.
A key measure of the recovery is GDP growth. Over the past four years, GDP growth has averaged 2.3 percent. GDP growth for Q3 2013 was an annualized 3.6 percent, including a boost from inventory accumulation that will detract from Q4 growth. In Q1 2006, 17 quarters into the last recovery, GDP was growing at 4.9 percent. The current economy has not been making up the ground it lost—it is barely staying afloat.
Unemployment is another important measure, usually declining a year or two after the recovery commences. Unemployment rates were 4.7 percent in March 2006, 5.7 percent in July 1995, and 6.6 percent in March 1987—four years and four months after the respective recoveries began. This time unemployment has not returned to pre crash levels. The unemployment rate remains at a stubbornly-high 7.3 percent, 1.6 percentage points higher than the average rate at this point in the previous four recoveries. Teen unemployment is currently 22.2 percent. The Labor Department’s broadest measure of unemployment, U-6, stands at 13.8 percent.
The share of the unemployed who have been without work for over 6 months is 36.1 percent. In March 2006 this rate was 18.4 percent, and it was 17.2 percent in July of 1995. Compared with past recoveries, the current level of long-term unemployment is posing serious problems for the economy.
Another fundamental measure of recovery is labor force participation. After recoveries are underway, labor force participation gradually increases, as people gain confidence, resume searching for work, and get jobs. This has yet to happen. Instead, labor force participation has dropped from 65.7 percent in June 2009 to 62.8 percent, the lowest since 1978. This is particularly pronounced among younger workers and is not due to retirements—labor force participation rates for the 55+ group are rising.
The labor force is still 1.5 million jobs short of where it was in December 2007, before the recession. There are barely enough jobs being created to keep pace with population growth, and far fewer than what is needed for the labor force to recover.
Food stamps also indicate the quality of recovery. The number of people enrolled in the Supplemental Nutrition Assistance Program—also known as food stamps—has grown by 37 percent since the recovery began, from 35 million to almost 48 million (which is 15 percent of the population). Workers are supposed to be recovering and becoming more economically secure, not regressing.
The other premise of the letter was that devaluation and inflation would follow quantitative easing. In early November 2010, when the letter was being prepared, a dollar bought 6.8 yuan. Now it buys 6.09. That represents significant devaluation. Standard measures do not suggest strong inflation. However, when the Fed does stop buying, or when banks are confident enough to start lending again, it is likely that inflation will rise.
As Professor Calomiris and Boston College professor Peter Ireland have written recently, it may be desirable to use quantitative easing to achieve the Fed's inflation target when nominal interests rates are near the zero bound. But in such circumstances, quantitative easing should be confined to purchases of treasury bills, not treasury bonds or privately issued securities. Treasury bills purchases are fully capable of accomplishing the legitimate inflation targeting goals of quantitative easing without generating politically damaging insolvency risks for the Fed.
The editors of e21 continue to support statements made in the 2010 letter. Unfortunately, outgoing Chairman Bernanke did not heed the economists’ advice—he instead undertook an open-ended, third round of quantitative easing. Incoming Fed Chair Janet Yellen should consider a change of course.