The Failure of Quantitative Easing

A perfect storm brews on the economic horizon while the Fed looks the other way.

With the specter of Quantitative Easing 3 raised this week during congressional testimony from Federal Reserve Chairman Ben Bernanke, there has been renewed debate over the impact of QE2 and whether more monetary stimulus is the right prescription for our economic ills. Some warn of an impending no-growth inflation crisis much like the phenomena seen in the 1970s. Others point to the artificial formation of another asset bubble. What few are brave enough to consider is the possibility of an asset bubble forming at the same time as heavy inflationary pressures build in a low-to-no-growth environment. Signs of this perfect storm have already surfaced.

The United States is currently in a low-growth environment. The 2011 first quarter GDP has grown a weak 1.9 percent while the 2010 growth rate was only 2.9 percent. That may count as a decent performance in normal times, but it's very low growth following the steep economic decline we recently experienced. Meanwhile, wages continue to remain flat and by some measures are in decline—not surprising given an unemployment rate of 9.2 percent. More than $2.1 trillion flowing from the Fed clearly has done nothing to mend the American job market. Asset markets on the other hand are booming.

Since the Fed began its campaign, the S&P has more than doubled, the Barclays aggregate is up 8 percent, and IPO pricings are signaling the next bubble. The latest major IPO to hit the street, LinkedIn, is trading at well-over 1,000 times its earnings. Plenty more companies will soon become public with price valuations that will make even that look cheap. Inflation is also beginning to creep higher and a commodity boom threatens to rapidly accelerate price hikes.

When solid underlying fundamentals of the economy contribute to inflation and to spiking asset prices, the Fed normally has a number of options at its disposal to curb the situation. But this situation is different. Now it's the Fed itself, via its purchases, productivity gains, and abnormal speculation that has created this strange environment.

Typically commodity run-ups, inflation, and asset bubbles are associated with and partially offset by healthy economic growth, hiring, and innovation through entrepreneurism. That is not the case today. Without a strong economy corresponding with the coming confluence of inflation and bubbles, the Fed may find itself helpless to act given its current balance sheet and extended zero-interest-rate-policy (ZIRP). 

Furthermore, the solution of either selling assets or raising interest rates would each run counter to the Fed's mandate to promote full-employment. (Not that it’s a good mandate.)

As Chairman Bernanke has made clear, the Fed is comfortable maintaining the status quo for the time being, keeping asset prices propped up by reinvesting QE purchases as they run-off. In an effort to shirk the responsibility of acting preemptively, the Fed maintains that the slack job market is mitigating the threat of inflation and/or an asset bubble. The Fed also points to inflation expectations as keeping conditions anchored. These two factors are providing an excuse to justify further asset purchases and the continuance of ZIRP because the Fed believes asset bubbles and high inflation cannot occur in an environment with high unemployment and stagnant wages. The looming perfect storm is not even on the Fed's radar.

For the Fed to take measures counter to its current policy something would have to change in the present environment, either a wage-price spiral or an unexpected (to the Fed) shift in inflation expectations. An asset bubble factoring into current Fed policy is not even conceivable at this point. And given its success at identifying the previous two, it most likely never will be.

The central (bank) irony here is that the Fed alone is keeping expectations low through its purchases. QE2’s $600 billion treasury purchases on top of the first round of quantitative easing clearly affected yields. Using them now as an indicator for future inflation is like using tech stock P/Es as an indicator for future growth in 1999. They are manipulated metrics. The Fed has artificially pushed down yields by bidding up prices, which not only skewed inflation expectations, but may also be contributing to a bond bubble. If nothing else, it has mispriced risk.

The very indicator the Fed is using to dictate a change in policy is being directly affected by its own policy. That paradox is also keeping the Fed from properly identifying pending problems in the economy. 

So a perfect storm brews on the horizon while the Fed looks in the wrong direction. The crippling affects from inflationary stagnation and from the recessionary onset of a busting bubble would line-up some very difficult decisions for the Fed. If both occur simultaneously, the Fed will be helpless to defend against the two-front assault on the economy. Indeed, the Fed won't even see it coming.

James Groth is a research associate at Reason Foundation. Anthony Randazzo is director of economic research at Reason Foundation. 

Editor's Note: We invite comments and request that they be civil and on-topic. We do not moderate or assume any responsibility for comments, which are owned by the readers who post them. Comments do not represent the views of Reason.com or Reason Foundation. We reserve the right to delete any comment for any reason at any time. Report abuses.

  • The Bernank||

    "Federal Reserve been veddy veddy good to me. Your American football, I don't know."

  • Bill||

    Not sure why people are down on the Fed. Ever since it was set up in 1913 it had done a bang-up job. It really prevented that Great Depression from getting out of hand. Think of how many jobs it created or saved back then. Otherwise the depression would have been much worse.

  • ||

    Indeed, I read it on the Internet that without the Fed's brave and wise steersmanship of our fortunes there would've been a zombie apocalypse in 2008 followed by a plage of locusts and a 100-foot tidal wave.

    Oh wait..were you being serious?

  • ||

    Don't joke about such things, the Zombie Apocalypse is coming!

    Shoot for the head, it only works if you shoot for the head!

  • Realist||

    Too funny.

  • ||

    The depression was much worse and much longer than it should've been. It was thought by Milton Friedman that the Great Depression was caused by the failure of the Federal Reserve.

  • ||

    Dang, I seem to have lost my pocket size copy of The Sayings of Chairman Ben.

  • ||

    ...very wishy-washy article -- some say this... some say that; this might happen... or not; the Fed may do this or that ... or believe this or that, etc.

    Please state facts and or firm opinions, not endless... idle conjecture.

  • ||

    Most libertarians have a knee-jerk hatred of the Fed. Its been baked in for years - probably from some Bircher pamphlets they saw as a teen.

    Because they lust for 19th century privately-issued bank scrip that went totally bust every 15 years.

    Yeah - that is a better system!

  • stfu||

    shrike is an anti-semite and a racist

  • Mr. FIFY||

    This assumes every Fed-hater has even casually glanced in the general vicinity of a Bircher pamphlet, let alone actually *read* the fucking things...

  • sevo||

    "Its been baked in for years - probably from some Bircher pamphlets they saw as a teen."
    Gee, shriek, you know who else liked the big lie?

  • Whappan?||

    Woodrow Wilson?

  • sevo||

    Among others.

  • Old Mexican||

    Re: shriek,

    Most libertarians have a knee-jerk hatred of the Fed.


    Pointing out 98 years of failures is hardly "knee-jerk."

    [...]probably from some Bircher pamphlets they saw as a teen.


    You have little clue of history. The false allure of central banking was already being criticized by some of the Founding Fathers. The Constitutional Clause prohibiting the states from issuing currency besides gold or silver indicated the framer's mistrust of fiat currencies. I believe the framers of the Constitution and the Founding Fathers lived way before John Birch - just sayin'.

    Because they lust for 19th century privately-issued bank scrip that went totally bust every 15 years.


    Only those banks that issued more bills than deposits went bust, you ignorant fool.

    Yeah - that is a better system!


    Yes, it is: you can choose with whom you do business. The current system leaves you NO CHOICE.

  • Red Rocks Rockin||

    Only those banks that issued more bills than deposits went bust, you ignorant fool.

    Today they get bailed out instead.

  • Bingo||

    Shrike is a Wall Street toady. He's a big fan of bailing out large corporations.

  • yonemoto||

    Also he hates poor people.

  • cynical||

    I just want gold. That's baked in from playing too many RPGs. Ideally, I'd like to go around punching monsters or public officials until gold sprays out into the air and lands in nice little piles.

  • Fatty Bolger||

    Kick your dog and a sword falls out of his ass. I'd like to know how that's supposed to work.

  • ||

    Yea ... printing money is always a good idea ... for the government.

  • ||

    "Because they lust for 19th century privately-issued bank scrip that went totally bust every 15 years."

    Yeah, who can forget reading about the First Proto-Depression of 1826, or the Global Scrip Bubble of 1890?

    The Fed took local insolvency and made it global. -- A *much* worse system.

  • Mark Stouffer||

    shrike said: "Most libertarians have a knee-jerk hatred of the Fed."

    Most liberals cannot understand reactions other than knee-jerk reactions. What they hate in others they despise in themselves. The treacherous are always wary.

    You've got it the wrong way round. Most people who hate the Fed, hate a government who constantly meddles in the free market and then blames market freedom, become libertarians.

  • NotSure||

    Yeah central banking is so great, just look at Europe and the ECB and the economic miracle it has produced...

  • fyngyrz||

    It's economics. It's made of endless, idle conjecture. What makes it interesting is it is endless, idle conjecture inflicted on you.

  • ||

    Confident prediction: there will be a QE3. Continued weakness in the economy or a weak market for very-low-interest Treasuries either one would guarantee it, and I think we're going to see both.

  • Mongo||

    So, basically you're saying that Obama will start writing his 3rd autobiography in about 17 months.

    What will he call it?

    YEAH, EAT YOUR FUCKING PEAS!

  • pmains||

    Eat your peas. Has there ever been a more perfect articulation of paternalistic government by philosopher kings?

  • ||

    Doesn't this represent a step down from "a chicken in every pot"?

  • Fatty Bolger||

    Don't forget the GM car in every garage.

  • Mr. FIFY||

    Team Red is paternalistic.

    Team Blue is maternalistic.

  • newshutz||

    both are nicompooptastic

  • ||

    Kind of reminds me of "let them eat cake"

  • ||

    Dreams of my father eating peas

  • Zeke Hyle||

    QE3 is pretty much a certainty now. The question is how long the oversized turd of our economy manages to spin around in the toilet bowl before being sucked into the pipes. If it lasts long enough, we'll do a QE4, too.

  • PP-l||

    Even more confident prediction: It will be called something else, or, most likely, be done completely under-the-table. I mean, it's not like they have to worry about being, you know, audited or anything like that.

  • ||

    And when QE3 fails we'll see QE4. At some point the dollar will stop being the world's reserve currency. Then the dollar will suddenly lose 75% to 90% of it's value over night.

  • ||

  • fish||

    Please state facts and or firm opinions, not endless... idle conjecture.

    What do you get when you lock two economists in a room?

    Three different opinions.

    (Thanks I'm here all week!)

  • ||

    Perhaps they should throw a knife in with them and yell "only one shall leave this room alive!"

  • Announcer||

    Put your hands together for fish! Don't forget to tip your waitresses and bartenders!

    And now... the comedic stylings of Paulie Krugnuts!

  • Mr. FIFY||

    You'd let ONE leave the room alive?

    You are far too gracious, Josh.

  • Old Mexican||

    The Fed has artificially pushed down yields by bidding up prices, which not only skewed inflation expectations, but may also be contributing to a bond bubble. If nothing else, it has mispriced risk.


    Welcome to ABCT hell...

  • ||

    At some point people will decline to accept dollars in trade for ANYTHING--recall the fate of the continental currency in the Revelutionary War era. The new phrase might well become, "not worth a dollar"

  • ||

    The very indicator the Fed is using to dictate a change in policy is being directly affected by its own policy. That paradox is also keeping the Fed from properly identifying pending problems in the economy.

    Even silly Microsoft Excel catches circular reference errors.

    Princeton economics professors, not so much.

  • space biologist||

    Halting proble

  • ||

    Simple response to the headline...

    Market compensation...
    more people understanding = less impact

  • ||

    Not tonight Bernie, I'm so tired from last night, and the night before, and before that...

  • Otto||

    alt-text: "11% unemployment? Whadda fuck ya want from me?"

  • ||

    Albert Einstein Quotes - "Insanity: doing the same thing over and over again and expecting different results." This sums up the Federal Reserve very well!

  • ||

    What no Tony?

  • Old Mexican||

    Re: comma44,

    What no Tony?


    Hey! No invocations allowed, you pagan.

  • Tony||

    WHO DARES TO DISTURB MY SLUMBER?

  • newshutz||

    Oh, NO! The beast with a thousand inanities awakes!

  • Old Mexican||

    Here's a much better article - by Peter Schiff.

    It Ain't Money If I Can't Print It!

    Excerpt:

    If anyone had lingering faith that Mr. Bernanke actually has a plan to end the US government's addiction to cheap money, the Chairman's semi-annual testimony to Congress should have washed it away. In addition to claiming that his money-printing has helped the US economy, Bernanke told Congress that gold is not money, people buying gold are not concerned about inflation, and the external value of the dollar has no influence on its domestic purchasing power. He even took a moment to stump for President Obama's plan to raise the debt ceiling.

    By claiming that gold is not money, the Chairman demonstrates his ignorance of much of monetary history. He told Congressman Ron Paul that he had no idea why central banks hold gold, before speculating that it might have something to do with tradition. Yes, traditionally gold is money, which is precisely why central banks hold it. And gold is money because central bankers like Mr. Bernanke cannot be trusted with a paper substitute.

    Bernanke further disputes the facts by claiming that the only reason people are buying gold is to hedge against uncertainty, or "tail risks" as he calls them. My advice to the Chairman is to ask the people who are actually buying it. As someone who has been buying gold myself for a decade, I can assure him that my gold buying has nothing to do with "uncertainty." In fact, it's just the opposite. I am buying gold because of what is certain, not what is uncertain. I am certain that Mr. Bernanke's incompetence will destroy the value of the dollar and unleash runaway inflation.

    If it were true that people bought gold to protect themselves from market uncertainty, as the Chairman claims, then the metal should have spiked in the midst of the '08 credit crunch. Instead, it fell along with most other assets. People instinctively fled into US dollars and Treasuries because of their long record of stability. What Bernanke doesn't understand is that his irresponsible monetary policy is undermining that faith in US assets, built up over generations. That is what's driving gold: easy money, negative interest rates, and quantitative easing.

    Finally, by claiming that the dollar's exchange rate has no effect on domestic prices, Mr. Bernanke demonstrates that he probably lacks the competence to be a bank teller, let alone Chairman of the Federal Reserve. A weaker dollar means Americans have to pay more for imported goods. But it also means domestic producers have to pay more for raw materials and imported components, which raises domestic production costs as well. It also means that more domestically produced goods are exported, reducing the supply and raising the price of what is left for Americans to consume. This is Econ 101.


    Know you know why Shrike loves Bernanke: because both are equally clueless.

  • Dan Smythe||

    The Perfect Storm is indeed brewing. It has been for a long time. One of several possible scenarios. 1. this is an ideal scenario for Obama to pull off some sort of 'bullshit' miracle to help him get re-elected. Remember every president wants to leave his term on a high note. Examples: see how stock markets always tend to 'pop up' before a president is up for re-election. 2. No one does anything about it and it all goes to hell in a hand basket. This would be good. Little does he average american citizen know that social unrest /and or civil war does flush out many rats. Examples: see American Revolutionary War and recent unrest in the Middle East. After all what got the U.S out of the last Great Depression?: WWII 1939-45

  • Metazoan||

    I disagree that WWII got the US out of the great depression. War is universally bad for long-term growth- it only gives the illusion of economic progress. It is fundamentally destructive of wealth and the minds who create it.

  • ||

    Man I never thought about it liek that before.

    www.complete-privacy.us.tc

  • ||

    And of course without the Fed, the federal government would have had to reign in spending decades ago. By now, it is difficult to understand in what reality these fellows live.

    Economists may have now surpassed lawyers in rigging the game.

  • ابداع ويب||

    thank you man

  • ابداع ويب||

    thank you man

  • Bradley ||

    Too many hyphens. Also effects not affects.

  • Mark||

    Should we try and improve the economy by essentially printing more money?

    Lemme think....

    Uh....

    Sure! What could possibly go wrong?

    I mean, they didn't mention anything about this being a really bad idea in say, Macroeconomics 101 or anything, right?

    Didn't this kind of solution work out great for the Italians?

    Yes, this is a very sound, reasonable approach to fixing our economy and frankly, I have to say that it has restored my faith government and caused me to reconsider my criticisms of interventionist policies.

    Also, I'm Santa Claus.

  • ||

    The article misses the biggest point: the Federal Reserve continues to print trillion of dollars in bogus bills. Eventually we'll have hyperinflation like Germany did in the 1920s. We have trillion dollar deficits as far ahead as the eye can see. And we have a dying economy that the Fed keeps trying to stimulate.

  • andy mike||

    Many thanks sharing fantastic informations. Ones websiteis consequently cool. We are impressed from the main factors that you’ve with this blog. The item reveals precisely how nicely people perceive this specific subject. Thank your share with me!
    http://www.fakeray-ban.com

  • andymiken||

    Many thanks sharing fantastic informations. Ones websiteis consequently cool. We are impressed from the main factors that you’ve with this blog. The item reveals precisely how nicely people perceive this specific subject. Thank your share with me! http://www.fakeray-bansunglasses.com.

  • Knockoff Ray Ban||

    As I site possessor I believe the content material here is rattling wonderful , appreciate it for your hard work. Thanks for your post and luckly to comment in your site!Every single mulberry neely bag are going to be laced with significance for the tiniest linked with info. http://www.ray-banknockoff.com.

  • replica Ray Bans||

    haha this seems to be a funny title, i like the drawing style as well. thanks for sharing, man! People have strong opinions around the table, and I am looking forward to listening to them, I've got my own opinion, which I am more than willing to share. http://www.replicaray-bansunglasses.com
    http://www.replicaray-bans.com

  • nikeshox||

    This is my first time i visit here. I found so many entertaining stuff in your blog, especially its discussion. From the tons of comments on your articles, I guess I am not the only one having all the leisure here! Keep up the good work.

  • ||

    Help

  • nanshuoxing1||

    It also means that more domestically produced goods are exported, reducing the supply and raising the price of what is left for Americans to consume.Chaussures Air Max

  • Nike Air Force 1 Low||

    is good

  • Matt R||

    Print more money? Sure! That's a great long term economic plan.

    bees for sale

  • joy||

    What few are brave enough to consider is the possibility of an asset bubble forming at the same time as heavy inflationary pressures build in a low-to-no-growth environment. http://www.petwinkel.com/pet-gstar-c-34.html Signs of this perfect storm have already surfaced.

GET REASON MAGAZINE

Get Reason's print or digital edition before it’s posted online

  • Video Game Nation: How gaming is making America freer – and more fun.
  • Matt Welch: How the left turned against free speech.
  • Nothing Left to Cut? Congress can’t live within their means.
  • And much more.

SUBSCRIBE

advertisement