Friday, June 03, 2011

Missing the Will to Fight

Gavyn Davies wonders where we can look for help as the US economy struggles to regain some forward momentum:
US economy: out of ammo?

The US employment numbers for May seemed to surprise the markets, but in fact they confirmed what we already knew from a string of earlier data releases, which is that the economy has slowed very markedly in recent months. The debate now is whether this slowdown has been triggered mainly by transitory factors – the fallout from the Japanese earthquake, stormy weather, and a spike in gasoline prices above $4/gallon – or whether it reflects a more fundamental malaise in the economic recovery.

...I am not usually disposed towards pessimistic nightmares about the US economy, but I am worried about the all-too-easy assumption, which is often heard from investors, that the Fed will automatically ride to the rescue if there are signs of a double dip recession. In fact, I have been told several times this week that QE3 is already a “done deal”...

...The Fed itself has done many studies which show that QE has had very similar effects to more conventional forms of monetary easing, but the evidence of the past 6 months has made many people sceptical about this comforting conclusion. Since QE2 was launched, real GDP growth has slowed markedly, while inflation and commodity prices have risen. Rightly or wrongly, another dose of the same medicine would certainly be a hard political sell.

And that is the source of my nightmare. If the present downward momentum in the economy were (unexpectedly) to continue, where would the rescue come from? With the Republicans in charge of the House, another fiscal stimulus seems improbable, to say the least. And even Mr Bernanke, who is clearly able to read the political tea leaves, has said that the hurdle to more Fed easing is “very high”. In these circumstances, the markets might suddenly conclude that the US cavalry is “out of ammo”.
Davies is right to worry. While transitory factors have played a role in the spring slowdown in the US economy, they only account for a portion of the problem. And unfortunately, I really don't think we can expect any new expansionary fiscal or monetary policy this year.

I would disagree with him about one crucial point, however: the reason that QE3 won't be tried this year is not, as Davies suggests, because QE2 proved ineffective. Rather, QE3 is simply not politically feasible for the Fed under present circumstances. Conservatives have attacked the Fed's program of Large Scale Asset Purchases (LSAP) not because they have actual evidence about its effects -- they don't -- but rather because they find it a convenient shorthand for criticising current macroeconomic policy in the US. Given fierce Republican opposition to expansionary policies, and in the context of the various threats they have made to curb the Fed's independence, Bernanke's hands are effectively tied this year.

So let's be perfectly clear about why policy-makers aren't fighting to save the recovery. It's not because they are out of ammo, or because the remaining rounds in their holster are defective. It's because the political will to fight for the US economy is simply not there.

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