A Symptom of Desperation? Querying QE3

When an economy is in a slump and the fear of debt overhang and default surrounds us, there is a tendency to tighten our belts. But these actions only serve to deepen the slump. Economists suggest that to offset private caution, we should resort to public sector stimulus. Hopefully, such stimulus is directed toward building things that boost our future productivity, like science and research, infrastructure repairs and upgrades, and education. In the short term, the economic activity created by these investments allows people to work out from under debt overhangs and leads to more private sector jobs. Investing in these things will also make it easier in the future to pay off the debt incurred in the slump.

When coherent and rational approaches have left the building, as they have in the current U.S. ideological conflict over the role of government, what else can still be done?

Expansionary monetary policy, aka "quantitative easing," is one thing, but its effectiveness is questionable. Advocates of QE believe creating the expectation of rising inflation is helpful. But in a slump, it is not clear how the Fed is connected to the inflation. The old adage "you cannot push on a string" is perhaps apt since monetary stimulus leads to a pile up of excess reserves at the banks rather than fresh lending.

Those who look at the impact of QE cite a narrowing of the spread between short-term and long-term interest rates. Others point to a compression of the spread between corporate bond rates and government bond rates that can, at the margin, get corporate investment moving --but right now the corporate sector appears to have a lot of cash in the vaults, so this channel may not produce much.

QE can also impact perceptions of the dollar's foreign exchange value. An announced QE program may lead to a decline in the dollar vis a vis foreign currencies and thereby stimulate activity in the export- and import-competing sectors.

So overall, QE is not likely to hurt much. It is mainly a symptom of desperation and reflects the dysfunction in Congress and the White House that has stopped us from using much more effective tools to spur the economy forward.

Cross-posted from New Deal 2.0.