Impact of Fed Stimulus Debated

helicopter-dropping-money2 Econintersect:  An article in The New York Times highlights the debate among economists about just how effective the QE (quantutative easing) by the Federal reserve has been in aiding economic recovery from The Great Recession.  Some economists feel it has had limited impact on the real economy, although none seem to argue that it has not buoyed the financial sector.  The aggregate efforts of the government to provide funds for the banks and the Fed to buy U.S. Treasuries and MBS (mortgage backed securities) reaches into several trillion dollars.Almost all of this new money (yes, the Fed “printed” new money to finance this) remains in the banking system where it basically extends the bank bailout process started by the Treasury and the Congress in the fall of 2008.  From the beginning with TARP, the purpose of the bailout efforts was “to get the banks lending again.”  That has not happened as commercial bank credit has continued to contract.  The following graph shows the real commercial bank credit numbers corrected for inflation by CPI (1982-84 dollars).

Real Total Credit Outstanding at Commercial Banks (1982-84 $)


The two spikes in credit total approximately $450 billion.  This is a small fraction of the liquidity added to the banking system by the government and the Fed.  On an inflation adjusted basis the banks have credit outstanding now that is less than the low in 2008 as the financial system and the economy were collapsing and more than $200 billion less than the credit outstanding at the official end of the recession.

The Fed has defended the QE policy as the only tool left (once interest rates have dropped to zero) to fight deflationary pressures.  Economists are divided on the effectiveness of QE as an economic stimulus.  Many are critical.  From The New York Times:

As the Fed’s policy-making board prepares to meet Tuesday and Wednesday — after which the Fed chairman, Ben S. Bernanke, will hold a news conference for the first time to explain its decisions to the public — a broad range of economists say that the disappointing results show the limits of the central bank’s ability to lift the nation from its economic malaise.

“It’s good for stopping the fall, but for actually turning things around and driving the recovery, I just don’t think monetary policy has that power,” said Mark Thoma, a professor of economics at the University of Oregon, referring specifically to the bond-buying program.

Mr. Bernanke and his supporters say that the purchases have improved economic conditions, all but erasing fears of deflation, a pattern of falling prices that can delay purchases and stall growth. Inflation, which is beneficial in moderation, has climbed closer to healthy levels since the Fed started buying bonds.

“These actions had the expected effects on markets and are thereby providing significant support to job creation and the economy,” Mr. Bernanke said in a February speech, an argument he has repeated frequently.

But growth remains slow, jobs remain scarce, and with the debt purchases scheduled to end in June, the Fed must now decide what comes next.

Some criticize the U.S. actions as similar to the QE efforts in Japan that started in 2001 in an attempt to staunch a deflationary spiral that was already nearly 10 years old.  Japan still has a stagnant economy.  Others, including Bernanke, maintain that the failure of QE in Japan was significantly caused by the time lag of ten years before implementation.  These economists maintain that the U.S. action was preemptive and, therefore, will have greater success.
Further discussion from the Times article:

A study published in February found that interest rates decreased, but only for companies with top credit ratings. “Rates that are highly relevant for households and many corporations — mortgage rates and rates on lower-grade corporate bonds — were largely unaffected by the policy,” wrote Arvind Krishnamurthy and Annette Vissing-Jorgensen, both finance professors at Northwestern University.

Another indication of its limited success: Borrowing has not grown significantly, suggesting that corporations — which are sitting on record piles of cash — are not yet seeing opportunities for new investments. Until they do, some economists argue that the Fed is pushing on a string.

“What has it done? It has eased credit conditions, it has pumped up the stock market, it has suppressed the dollar,” said Mickey Levy, Bank of America’s chief economist. “But does the Fed think that buying Treasuries and bloating its balance sheet is really going to create permanent job increases?”

Some of the current discussion is reminiscent of The Great Depression, where repeated policy shifts between stimulus and fiscal responsibility created an uncertain picture of what policies were actually beneficial to the broader economy.  From 1931 through 1940 the shifting fiscal policies (which contained periods of significant monetary stimulus) did contribute to some of the strongest periods of GDP growth in the nation’s history.  There were also periods of increasing employment, although in no year during that time period did unemployment fall below 14.2% (1937).  Four of the ten years saw unemployment above 20% and two years were around 25% (24.1% in 1932 and 25.2% in 1933).
The GNP (Gross National Product) grew at a compounded annual rate 0f 7.0% from 1933 through 1940.  This is far higher than any eight year period since World War II.  Yet, for all the higher growth in output, the nation’s Main Streets remained blighted for the most part; the wealth of industry was recovering from the great collapse 1929-32, but the unemployment burden was not substantially lifted from the populace.
The caused FRD’s (Franklin Delano Roosevelt) Secretary of the Treasury, Henry Morganthau, Jr., to famously say in 1940 (from Wikipedia): 

“We have tried spending money. We are spending more than we have ever spent before and it does not work. And I have just one interest, and if I am wrong … somebody else can have my job. I want to see this country prosperous. I want to see people get a job. I want to see people get enough to eat. We have never made good on our promises. … I say after eight years of this Administration we have just as much unemployment as when we started. … And an enormous debt to boot.”

Morgathau was a strong advocate for balanced budgets and a strong anti-Keynsian voice in the 1930s.  In 1937 he said in a speech (from Wikipedia):

“We want to see private business expand. … We believe that one of the most important ways of achieving these ends at this time is to continue progress toward a balance of the federal budget.”

His influence was felt in 1937 as major tax increases and larger bank reserve requirements were instituted.  The year 1937 also saw the start of a severe recession that has been called “the depression within a depression.”  To this day economists argue the cause and effect relationships between the tightened monetary and fiscal policies in 1937 and the recession that started in that year.
Sources:  Federal Reserve Bank of St. Louis, The Statistical History of the United States, Wikipedia and The New York Times 


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