Ben Bernanke has done his bit to help the American economy. Now the politicians must do theirs.
Even by the standards of a weak recovery, America’s economy has looked frail lately. Growth has sunk below 2%. Unemployment is stuck above 8%. Factory activity seems to be shrinking. Yet there is no mistaking the green shoots of optimism, in particular on Wall Street: the stockmarket has hit its highest level since 2007. Consumer confidence is edging up, and along with it approval of Barack Obama, raising his odds of re-election even before Mitt Romney’s gaffes.
Give credit to central bankers and their printing presses for the improving mood. On September 13th the Federal Reserve said it would buy mortgage-backed securities and other assets without limit, until it had made clear progress in bringing down unemployment. A week earlier the European Central Bank (ECB) promised to buy as much sovereign debt as necessary to squelch fears of a euro break-up. And this week the Bank of Japan extended its asset-purchasing programme by ¥10 trillion ($128 billion). These announcements have pleased investors, who like the fact that central bankers, unlike politicians, can print all the money they wish.
Nothing to fear but fear of inflation
Is the market’s optimism warranted? The Fed has conducted rounds of similar “quantitative easing” (QE) before, with uninspiring results. Republicans disparaged the Fed’s money-printing as an ineffective “sugar high”; Mr Romney has vowed to replace Ben Bernanke, the Fed’s chairman, when his term ends in 2014. Other critics raise two principal objections; neither, however, undermines the case for QE.
The first is that it will jack up inflation and so do more harm than good. That is not likely. Loose monetary policy fuels inflation when the economy is overheating, not when it has lots of spare capacity, as now. The Fed’s anti-inflation reputation is so strong that it may have undermined QE’s efficacy: investors have assumed that as soon as inflation edged above the Fed’s 2% target, the monetary medicine would be withdrawn. By setting his sights on lower unemployment, Mr Bernanke has now signalled that if inflation drifts above 2% he will not immediately reverse course. This should help persuade households to spend and businesses to invest now rather than let inflation eat away their savings.
The second criticism is that more QE will not help because what ails America’s economy has nothing to do with high interest rates. There is some truth to this. In the wake of debt-driven financial crises, households and businesses typically spend years whittling down debts, and are much less sensitive to the lure of lower interest rates. In America borrowers who would like to exploit the lowest mortgage rates in a generation often find they cannot because of tightened underwriting standards. And the Fed clearly cannot do anything about a slowing world economy and Europe sliding into recession.
Yet none of those is a reason for the Fed to stand pat. Previous QE may not have been a cure-all, but it has helped. By lowering long-term mortgage rates, for instance, it has boosted the housing market. This latest round of QE differs from its predecessors because, as with the ECB’s announcement, it depends not just on the brute force of bond-buying but also on changing expectations. And in the coming year many of the forces that have been holding back the recovery should weaken, making the Fed’s medicine more potent. The process of deleveraging is well advanced. The housing market is healing and, as house prices rise, consumers will feel richer and banks will be more willing to lend. And although the ECB has not solved the euro crisis, it has made a traumatic break-up less likely.
One problem, however, threatens to get significantly worse: fiscal policy. At the end of this year George Bush’s tax cuts expire and automatic spending cuts take effect, delivering a hit worth 5% of GDP a year, easily enough to tip America back into recession. Even if politicians come up with a way to delay this “fiscal cliff”, the economy will still feel the drag of tighter fiscal policy as previous stimulus measures expire and planned austerity measures take effect.
Both Republicans and Democrats agree that the cliff must be avoided. But they have radically different ideas about how to do so, and are thus leaving it until after the election. For a business trying to plan ahead, delay makes no sense. The elements of what should be in a deal are obvious. America urgently needs a medium-term plan that both raises revenues by reforming taxes and arrests the long-run growth of spending on entitlements such as pensions and health care for the elderly (Medicare). It also needs the process to be gradual. Accomplishing this will require the Republicans to erase their red line against raising taxes, and the Democrats to erase theirs against touching Medicare benefits. If they do not agree to that, there is nothing Mr Bernanke can do to help them.
(The Economist)
