Chad Stone is chief economist at the Center on Budget and Policy Priorities.
After talking for some time about sluggish job creation, the Federal Reserve finally did something about it. Its latest move to stimulate the economy, QE3, is no silver bullet, but it's our best and only hope to boost the recovery when congressional gridlock prevents appropriate tax and spending policies.
Quantitative easing, or "QE" as it's known, is one of the major nontraditional monetary policy tools that the Fed has used since the financial crisis began in the summer of 2007: large-scale purchases of financial assets with relatively long maturities, such as government bonds and mortgage-backed securities, in an effort to lower longer-term interest rates and stimulate spending. The Fed has resorted to asset purchases because the traditional tools of monetary policy are not available.
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In the years leading up to the financial crisis and Great Recession, a broad consensus of economists believed that the Fed's control over short-term interest rates through purchases or sales of short-term Treasury securities was the most effective policy lever to moderate the ups and downs of the business cycle and, in turn, prevent big increases in unemployment or inflation. The so-called "automatic stabilizers"—countercyclical changes in tax revenues and unemployment insurance and other spending that varies with economic conditions—were considered sufficient on the fiscal side.
The financial crisis, which sent the economy hurtling toward an abyss, shattered that complacency. By the end of 2008, the Fed had done all it could with traditional tools to stimulate the economy by pushing short-term interest rates to their lowest practicable level—the so-called "zero lower bound." The Fed also acted as lender of last resort to troubled financial institutions through a variety of emergency lending programs and the Bear Stearns and AIG bailouts.
These actions, together with the widely misunderstood and maligned Troubled Asset Relief Program and 2009 Recovery Act, prevented a very bad situation in late 2008 and early 2009 from growing much worse and helped stabilize the economy by mid 2009, according to many objective observers. But, by then, the economy was in a very deep hole. Unemployment was high and inflation was nonexistent (in fact, the risk was destructive deflation). With short-term rates at the zero lower bound, the Fed turned to large scale asset purchases to bring down longer-term rates directly.
By traditional measures, these purchases have generated a massive increase in the money supply, but those measures are a poor guide to the true impact of Fed actions under extraordinary economic conditions. As a result, I don't find the critics who think QE3 will have impacts on inflation and the dollar that will significantly damage the economy credible. Rather, I'm with those who view QE3 as an appropriate response to an economy with too much unemployment and little risk of inflation and therefore are cautiously optimistic that it will help.
Here's what Fed Chairman Bernanke said at the press conference announcing QE3:
Our assessment and that of the research literature is that the polices we've undertaken have had real benefits for the economy, that they have provided some support, that they have eased financial conditions, and help reduce unemployment. All that being said, monetary policy, as I've said many times, is not a panacea. It's not by itself able to solve these problems. We're looking for policy makers in other areas to do their part. We'll do our part and we'll try to make sure that unemployment moves in the right direction but we can't solve this problem by ourselves."
He's pretty much saying, "I'm looking at you, Congress, to step up to the plate."
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