The cast change coming at the Federal Reserve puts monetary policy on center stage. Janet Yellen will soon be replacing Ben Bernanke in the lead role as chairwoman.
Yellen is clearly qualified as an economist and has experience as vice chairwoman at the Fed. But no one is ever really ready to deal with the intensity and unpredictable nature of attacks on the central bank’s actions … and on its star.
Concern about the ability to “take the heat” is an issue now because of the growing skepticism and criticism of the Federal Reserve’s central policy: quantitative easing. Quantitative easing is a collection of central bank actions that inject liquidity into the banking system in order to keep short-term interest rates as low as possible — currently close to zero. The idea behind it is to keep the banks’ cost of funds low in order to encourage lending and promote economic growth and jobs.
The largest single financial mechanism supporting this policy is the Fed’s purchase of federal debt — approximately $80 billion each month — allowing the government to continue spending at high levels without creating a wave of destructive inflation. These purchases, along with others, have inflated the central bank’s balance sheet to nearly $4 trillion.
Yellen strongly supports this policy, believing that it is the best way to encourage economic growth and employment. There has been criticism of the policy, though, mostly based on what it was doing to our national debt picture and to the economic prospects of future generations of Americans.
Until recently the debt argument and its threat to the future haven’t been able to overcome the promise of jobs and economic growth in the present. Now, though, there is a growing realization that the promise of quantitative easing has a delivery problem. The evidence that it has worked effectively has been unconvincing thus far and there is more hope than evidence that it will work in the future.
Economists’ opinions on this issue are split not only along both theoretical and political lines. There is little disagreement, though, that the years of artificial money creation and low interest rates have distorted our economy and the economies of Europe and Japan which have adopted similar policies.
The McKinsey Global Institute, the research team of the international management consulting firm, has attempted to quantify the distortions that quantitative easing has caused. In their recently published report, “QE And Ultra-low Interest Rates: Distributional Effects And Risks,” they estimate the overall impact of easy money policies on some specific groups within the economy — the winners and losers — and look at the risks of pursuing this monetary policy for extended periods of time.
Their analysis found that, unsurprisingly, borrowers benefited while lenders lost ground. And since governments are the super-borrowers in modern economies, they benefitted the most. In the economies of the U.S., the U.K., the Eurozone, and Japan, from 2007 through the end of 2012, the governments, “…had collectively benefited by $1.6 trillion, through both reduced debt service costs and increased profits remitted from central banks.” Just over half of that, $900 billion, went to the U.S. government.
While the governments were raking it in, though, households were big losers. The report estimates that “… households in these countries together lost $630 billion in net interest income,” noting also that, “Younger households that are net borrowers have benefited, while older households with significant interest-bearing assets have lost income.”
In its discussion of the risks of this kind of monetary policy, MGI report expresses concern about what happens when quantitative easing and ultra-low interest rates come to an end. Our own concerns about this are that an overvalued stock market that is already twitchy about even a gradual reduction of Federal Reserve purchases of Treasury bonds should keep any central banker awake at night.
Why have we kept pursuing this monetary policy when it is of questionable effectiveness in promoting economic growth, and has created a debt bubble large enough to risk a rerun of 2008’s financial implosion?
The answer may be found in a movie classic, “An Officer and a Gentleman.” In it, officer candidate Richard Gere has been pushed to physical and emotional exhaustion by drill sergeant Louis Gossett Jr., who demands to know why he doesn’t just quit. Gere breaks down and sobs, “I got nowhere else to go.”
That is our situation in monetary policy. We are pursuing artificially low interest rates and quantitative easing because we’ve got nowhere else to go.
James McCusker is a Bothell economist, educator and consultant.