Quantitative Easing’s Chickens Coming Home to Roost
Recent U.S. political and financial market developments should give Federal Reserve policymakers pause as to the further resort to quantitative easing should the U.S. economy falter in the period ahead. Since quantitative easing policies have been an important contributor to the sense of economic unfairness that underlies the electorate anger being expressed in the run up to the presidential elections. They have also been the principal cause of the global financial market turbulence that has been all too much in evidence in the first quarter of this year.
Since 2008, the Federal Reserve has engaged in three rounds of quantitative easing that has enormously expanded the size of the Federal Reserve’s balance sheet from $800 billion to around $4.5 trillion at present. It has done so with the intention of stimulating the U.S. economy through increasing asset prices and through encouraging more risk taking by lenders. In the process, the Federal Reserve has helped to produce a strong bull market in equity prices and a large reduction in borrowing rates for high risk borrowers both at home and abroad. It has also resulted in extraordinarily low interest rates on bank deposits and on other instruments of household saving.
While the Federal Reserve might claim that its policy of aggressive quantitative easing helped to shorten the U.S. economic recession and to promote the gradual economic recovery of the past several years, it also contributed to a sense of economic unfairness among a broad segment of the electorate. Equally troubling, it seems to have set up the stage for large corrections in both domestic and global financial markets that could entail substantial long run costs to the American and global economies.
At a time that a strong boom in equity prices substantially boosted the wealth of stockholders, who for the most part are in the upper income brackets, real wages continued their long-run secular stagnation. Similarly, at a time that equity holders were prospering on the back of a rising stock market, savers, especially in the older age brackets, were seeing their interest earnings decimated. It should be little wonder then that a large part of the electorate are now clamoring for a basic change in economic policy direction that might be of greater benefit to their own economic wellbeing than have past policies.
The Federal Reserve’s policies have also set up the stage for considerable financial market turbulence. It has done so by artificially boosting asset prices and by encouraging borrowing at artificially low interest rates that do not reflect the likelihood of the borrower eventually defaulting on the loan. It has also contributed to a super international commodity price-cycle that is now in the process of busting as well as to major economic imbalances in a number of key emerging market economies. This would seem to make the financial markets particularly vulnerable to a major setback as the process of normalizing interest rates continues.
Considering the important long-run political and economic costs that aggressive quantitative easing policies will all too likely have entailed, it would not seem to be too early for the Federal Reserve to consider alternative approaches to stimulating the U.S. economy when it next falters. Among the ideas that warrant serious attention must be Milton Friedman’s famous idea of “helicopter money”, whereby the Federal Reserve would finance a government check to all the country’s citizens. Such an approach would more than likely succeed in stimulating the economy in a manner where all citizens rather than only a portion benefit. In addition, it would spare us from the creation once again of major distortions in both domestic and global financial markets that would only set up the stage for the next global financial crisis.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a Deputy Director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.
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