QE2 finally pulls into port

Almost eight months ago, the Federal Reserve announced their intention to launch a second round of “quantitative easing,” otherwise known as printing money. In the absence of policies that promote economic growth, the Fed used the one tool they had to encourage investment and enhance exports, which was to devalue the dollar in a way that discouraged cash hoarding. That project comes to an end today, and the Washington Post notes that the results are less than appealing:


The effort, which became known in financial circles as the second round ofquantitative easing, or QE2, was the Fed’s effort to avert a slip into another recession and toward deflation, or falling prices. As it ends, it shows more than anything the limits of the power of monetary policy to correct what ails the U.S. economy.

Economic growth is set to be somewhere around a 2 percent pace in the first half of 2011, when the QE2 bond purchases took place. That is slower than the economy’s long-term growth path and nowhere near enough to dig out of the nation’s deep economic hole.

It’s not that QE2 had no impact. Inflation was well below the Fed’s unofficial target of around 2 percent last summer, and the chance that deflation, or falling prices, might take hold seemed real. That risk is now minuscule, and inflation is roughly in line with the Fed’s target. …

“If you come at it from the point of view that you think deflation risk was significant last summer and you want to avoid that, QE2 was a success,” said Michael Gapen, senior U.S. economist at Barclays Capital. “If you look at it from the point of view that you wanted to make the recovery stronger and more durable, you would have a lingering bad taste in your mouth.”

How successful has QE2 been? Let’s look at the meta numbers for the economy. In 2010Q3, the annualized GDP growth rate was 2.6%, and in Q4 just before the purchases began, it was 3.1%. The QE2 purchases began in January, and the final 2011Q1 number is 1.9% and Q2 is looking at falling below that.

Employment numbers don’t look very good, either, although it’s not as bad at the GDP series. In November 2010, the unemployment rate was 9.8%, which equaled a high for the year. That fell a full percentage point by March, but has since risen again to 9.1%. We have added about 160,000 jobs a month since November, which barely exceeds what is needed to keep up with population growth. Meanwhile, the latest indicators suggest that we’re going to start shedding jobs and may be tipping perilously close to recession.

Some will argue that the problems in 2011 are more external, with gas prices soaring. But that’s part of QE2. One of the motives of the Fed was to encourage exports at the expense of imports by weakening the dollar. The US imports most of its oil, which means that a weaker dollar makes fuel more expensive, leading to inflation in retail markets as well. A few people predicted this very outcome when the Fed announced its QE2 project — one of whom was Sarah Palin, who got roundly ridiculed for her prediction, which turned out to be all too accurate.

The Post notes that the stock market did well during QE2, which is true enough. It’s also true that the rise isn’t as impressive because of the weakened dollar. Artificially inflating the dollar means that price rises don’t indicate a real increase in value, since the dollar doesn’t have the same buying power. On January 1, when the Fed began its QE2 spree, the Dow Jones was at 11670.75; it’s now at 12261.42 as of yesterday’s close. That’s an increase of 5% in six months, which is decent but not terribly impressive, considering the inflation conducted by the Fed to boost it. Now that QE2 has come to an end, we’ll see how much of that momentum continues; I’m betting on not much.

It’s not the Fed’s fault that this didn’t work, and it’s still worth noting that the Fed mainly wanted to avoid deflation, which it did succeed in preventing. The Fed has no other tools left in its bag to boost the economy. The money policy is as loose as it could possibly be at the moment. The problem with the economy is not the money supply, but the economic and regulatory policies of the Obama administration. Until those change, we won’t pull out of the stagnation cycle we’ve seen for the past two years.