Daniel Gross

Why Investors Shouldn’t Count on QE3

Contrary Indicator

On Wednesday the stock market was muddling through another boring day. Then at 2:00, the major indices took a brief dive. The reason? The minutes from the June Federal Reserve Open Market Committee's meeting were released. Investors were disappointed that the central bank was not promising more efforts to stimulate the flagging economy.

This reaction may be the most convincing argument yet against the assumption that markets are efficient. For how could anyone be surprised that the nation's central bank has run out of ideas, energy and desire to goose the U.S. economy?

In 2008 and 2009, the Federal Reserve undertook a series of extraordinary exertions in 2008 and 2009 to save the economy from a second Great Depression (go read David Wessel's In Fed We Trust for the back-story). Between 2009 and 2011, the Fed engaged in two big spells of quantitative easing — creating money to purchase assets such as government bonds and mortgage-backed securities in the hopes of bringing down long-term interest rates.

But since the second round of quantitative easing ended in July 2011, the Fed has indicated — time and again — that it is essentially done. It's true that the Fed kicked off a third round of quantitative easing in the fall of 2011. But Operation Twist, which involves selling short-dated assets the Federal Reserve already owns and using the proceeds to buy longer-dated assets, is a half-measure. If low long-term interest rates were the tonic for America's lack of demand and unemployment crisis, then the economy would be growing at 4 percent.

More significantly, you can see it in Bernanke's body language, his tone, his affect at press conferences and in his congressional testimony. After five years of fighting crises, of carrying the burden of economic growth on his back, Bernanke and his colleagues are exhausted. All the aggression seems to have been spent. The Fed has done a great deal, and all Bernanke has to show for it is a tepid growth rate and the opprobrium of his fellow Republicans. In recent weeks, he's taken to pleading with Congress to help boost demand and remove uncertainty by dealing with the fiscal issues it faces in a rational manner. "I'd be much more comfortable if Congress would take some of this burden," Bernanke said in June. But of course, Bernanke knows that won't happen soon. Hence, the weary resignation.

A great deal has been made of the incompetence of the European Central Bank. Thus far, four of the nations for which it makes monetary policy have sought bailouts. But the Federal Reserve isn't exactly covering itself in glory. The Fed has a dual mandate — to promote price stability (generally defined as keeping inflation around two percent at an annual rate) and to promote full employment. As economists Justin Wolfers and Betsey Stevenson note on Bloomberg View, it is manifestly failing on both those objectives, and has been doing so for many months. Inflation is running at about 1.5 percent, according to the Fed's preferred method of measurement, while the unemployment rate stands at 8.2 percent.

But the Fed, firmly in the grips of an enveloping ennui, doesn't seem to care. The minutes from June are a rehash of the Fed's communications for the past several months. Things are slow. Unemployment is unacceptably high. Government austerity is hurting demand. Things are bad, but they should get moderately better over the coming months. We're going to keep doing what we're doing, and if things get significantly worse, we might possibly potentially consider thinking about doing something else.

There are plenty of explanations for the Fed's passivity. The members of the FOMC spend a lot more time with people who are freaked out about the possibility of inflation than they do with people who suffer as a result of unemployment. And so it's no surprise that lower-than-expected inflation and higher-than-expected unemployment is an acceptable risk. Jealous of the Fed's independence, they don't want to take any action in the middle of an election year that could be seen as favoring the incumbent. Like most forecasters, they have an inexact understanding of the forces affecting economic growth in the short- and long-term. As a result, they're always fighting the last battle rather than anticipating the next crisis.

All those explanations have some merit. But I prefer a simpler one. Bernanke & Co. are humans. It's very hot in Washington this summer. They're tired, frustrated and beaten down by the persistent political and economic crises in the U.S. and Europe. After years of frenetic activity, they need to take a break — which is essentially what the FOMC is doing now.

Daniel Gross is economics editor at Yahoo! Finance.

Follow him on Twitter @grossdm; email him at grossdaniel11@yahoo.com.

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