QE3 Could Be Back on the Table
Federal Reserve Chairman Ben Bernanke's speech at the National Association for Business Economics conference on Monday seems to have put the possibility of a third round of quantitative easing -- QE3 -- back on the table.
Here's the money quote: "I also discussed long-term unemployment today, arguing that cyclical rather than structural factors are likely the primary source of its substantial increase during the recession. If this assessment is correct, then accommodative policies to support the economic recovery will help address this problem."
I agree with the chairman's view, expressed elsewhere in the speech, that improvement in the labor market is less than it seems. Rather than use the unemployment rate as my measure of the labor market, I prefer to use the employment-to-population ratio, which I've mentioned before. This is basically total persons employed divided by the total working-age population. I like this metric because it measures labor slack, which is what matters for interest rates, and it also avoids the whole problem of determining who is in the labor force, which is always problematic.
Right now, the employment-to-population measure has 58.6% of the adult population currently employed. The non-recessionary range in the 1990s and 2000s was between 63% and 64.5%, dipping down into the 62% area after the 2001 recession. Consider what it would take for this ratio to climb back to 62%, which again, was the previous recession low.
Employment/Population Ratio
Bureau of Labor Statistics, Brown & Co.
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It would take 820,000 in new jobs per month over the next 12 months to get back to 62%. It would take 476,000 per month over the next two years and 362,000 per month over the next three years to get there. Note that we're assuming normal population growth, which is why the longer this goes, the more total jobs we need.
If you are the Fed, you look at this and you compare the current pace of job growth with what is needed to get back to "normal" and quickly conclude that you can't be accommodative enough. Full pedal to the metal!
But I actually don't think Bernanke is as focused on jobs as Monday's speech made him seem. If you want to understand his thinking, look to his lecture series he's currently giving at George Washington University. Full video and transcripts are available online.
In this series, he goes to great lengths to explain the mistakes the Fed made in the past, particularly its "liquidationist" tendencies early in the Great Depression, and more to the point, its anxiousness to tighten policy in 1937 to stem inflation that was nonexistent. Deep down, Bernanke may believe that growth leads to employment gains. I've read a lot of his old academic work, which seems to fit this view. Further, he seems to believe that the Fed can do a lot more to retard growth than it can to foster growth. In other words, if it tightens policy, it will slow growth down. If it loosens policy, it can goose growth only in so far as policy was too tight beforehand.
Put the talk of QE3 into that prism. What does it mean? If he believes the Fed has more power to slow growth than to accelerate it, then what he's really worried about is the Fed tightening policy too soon. Furthermore, since he directly controls only very short-term rates, there is a risk that the market tightens policy for him. For example, the market might see some improving data and assume that that implies future rate hikes. Intermediate-term interest rates would rise, and in a sense that would create tighter money. Bernanke feels strongly that this needs to be prevented.
I believe this talk of QE3 is really about forestalling any nascent sense in the markets that the Fed is coming off its 2014 pledge. The QE3 talk may die down, or the Fed may actually do some minor version of QE3. But the intended impact won't be about the direct effects of long-term asset purchases. It will be about communicating the Fed's resolve to keep monetary accommodation coming until overall liquidity conditions return to normal.
I'm not 1/100th the economist that Ben Bernanke is. But I humbly submit that I'd prefer another path, one where the Fed simply communicates some simple goal, such as a target for the price level or nominal GDP, and then does whatever it has to in order to get there. Then there wouldn't need to be all these machinations around QE3 or Operation Twist or whatnot, but at the same time, we'd know that rates aren't rising anytime soon.
But this is what we have. In the long run, this might result in some serious inflationary problems, or it might force the Fed to hike rates aggressively at some point in the future to stamp out the inflation. But all that is quite a ways off. For now, assume that rates will remain low for a long time.
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