The Federal Reserve’s new round of Quantitative Easing (QE3) consists of purchasing $40 billion worth of mortgage-backed securities every month and injecting corresponding liquidity into the system. After Mr. Draghi at the European Central Bank used the term ‘unlimited’ to characterise his intervention one week earlier, Mr. Bernanke used the term ‘open-ended’. That means ‘no end in sight’. In parallel, the ‘Zero Interest Rate Policy’ will be maintained until mid-2015.
QE1 and QE2 have not produced the predicted growth, so we’re left wondering: why a new round of QE?
Some see politics as a possible driver. The idea is that this new QE would temporarily boost the economy just before the US elections. The incumbent US president wants to avoid at all costs a return to recession before the election, although the Fed should be independent of such political considerations.
However, there is an economic case for the Fed’s move. Despite the considerable ‘public’ money creation by central banks, ‘private’ monetary creation by banks is very weak: they are not lending at normal levels and are leaving their cash at the central bank. The combined effect resembles that of a restrictive monetary policy, hence relatively low rates of inflation, despite the opening of the taps of ‘public’ money by central banks. Many economists therefore recommend a variety of activist policies.
But there seems to be a problem with this reasoning: monetary policy is certainly important for employment (which is the new declared target of the Fed) and growth, but other elements also matter, such as an unhealthy business climate, regime uncertainty, restrictive labour policies and taxes on labour, all of which are powerful brakes on recovery. Flooding the economy with liquidity won’t necessarily do the trick if reforms are not undertaken to tackle these other issues.
At the same time, there are unintended consequences from such loose central bank policy. In the past it has fuelled bubbles. Injections of liquidity may not fuel investment in productive enterprises (assuming a bad business climate, regime uncertainty, etc.) but instead may drive speculation in commodity markets, with counterproductive effects. An increase in oil prices, for example, is likely to have a negative effect on recovery in the US. In parallel, the announcement of a Zero Interest Rate Policy for the next three years means that a bubble will not be burst by an increase in interest rates: it is in fact a clear signal for the creation of a new bubble on this period.
These unintended consequences affect the rest of the world, for example through the impact of a ‘liquidity flood’ on food markets. And with increasing inflation expectations, purchases of consumables may of course increase: people, especially in poor countries, will rush to buy sugar, oil and rice for fear of price increases and thereby contribute to a price spiral.
China has already warned it fears Western inflationary monetary policies will end up generating social unrest in the Chinese hinterlands because of soaring food prices. US monetary policy may therefore increase tensions with China.
In the Middle East, QE2 precisely corresponded to the Arab Spring, a movement of liberation then celebrated as a progress. Unfortunately two years later, promises of freedom have only vaguely materialised: populations still live under an ‘economic apartheid’ based on cronyism. Protests against soaring food prices partly due to US monetary policy might soon erupt, threatening political stability in this strategically important region.
When the ‘unconventional’ becomes conventional danger lurks ahead. That just a few men can hold so much power is unbearable. More than ever, the world needs firewalls against centralised decisions that can have such devastating unintended consequences. Perhaps it is now time to question the centralisation of such power and to question the institution of central banking itself.
Dr. Emmanuel Martin is the editor of the AtlasNetwork francophone project www.UnMondeLibre.organd the director of the Institute for Economic Studies – Europe.