Are you ready for another round of reckless money printing from the most activist Federal Reserve in U.S. history? Last week, the doves (easy money advocates) on the Federal Open Market Committee (FOMC) started laying the groundwork for a third round of quantitative easing. Is that a tacit admission that Operation Twist, the most recent real-time experiment in monetary policy, has failed? Probably, but a majority on the Fed believe money printing stimulates the real economy, despite all of the commonsense evidence to the contrary.
How do members of the Fed reach such a conclusion? According to modern-day Fed reasoning, the success of monetary policy can be measured in the performance of the stock market. The S&P 500 rose almost 30% during the last round of quantitative easing so QE2 was deemed a success. The fact that GDP growth slowed from 2.5% to 1.3% as higher food and fuel prices sucked the wind out of consumer spending doesn’t register at the Fed.
The failure of QE2 certainly doesn’t register with Fed Governor Daniel Tarullo, an Obama appointee and former Harvard law professor. Last week, Mr. Tarullo gave one of his only speeches as a Fed governor on monetary policy. Mr. Tarullo’s focus was strategically placed on the labor market. He argued that a shortfall of aggregate demand, a cyclical factor, is more responsible for the nation’s high unemployment rate than structural factors. Mr. Tarullo cited Fed-generated research (no conflict there) that indicates structural factors account for only a minor portion of the rise in unemployment. The distinction between cyclical and structural unemployment is critical for Fed policy. If unemployment is cyclical, Mr. Tarullo can at least make a case for more Fed stimulus. If unemployment is structural, additional Fed easing would do more harm than good.
After arguing that unemployment is cyclical, Mr. Tarullo tells us “There is need, and ample room, for additional measures to increase aggregate demand in the near to medium term, particularly in light of the limited upside risks to inflation over the medium term.” What additional measures does the Fed governor have in mind? “I believe we should move back up toward the top of the list of options the large-scale purchase of mortgage-backed securities (MBS), something the FOMC first did in November 2008 and then in greater amounts beginning in March 2009 in order to provide more support to mortgage lending and housing markets.”
Mr. Tarullo supports QE3 in the form of large-scale purchases of mortgage-backed securities. Sadly, he is not the only voting member of the FOMC who supports QE3. Charles Evans, the president of the Federal Reserve Bank of Chicago, is on record as supporting a third round of money printing. And in a speech last Friday, Vice Chair of the Federal Reserve Janet Yellen officially threw her support behind another round of money printing. To wit: “Nonetheless it is worth noting that the scale of the maturity extension program is necessarily limited by the amount of our holdings of shorter-term securities; furthermore, purchasing a very large portion of the outstanding stock of longer-term Treasury securities could potentially have adverse effects on market functioning. Thus, securities purchases across a wide spectrum of maturities might become appropriate if evolving economic conditions called for significantly greater monetary accommodation.”
The Fed has lost its bearings and is losing credibility by the day. CPI inflation is running at 3.9%—and voting members of the FOMC are still advocating for a third round of money printing. We’ve had 0% interest rates for three years and two rounds of quantitative easing, yet unemployment remains over 9%. Money printing does not create jobs. QE3 will only further distort financial markets and inflate food and energy prices, hurting the very people it purports to help.
Jeremy Jones, CFA
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