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Why the Fed Should Not Do QE3

Interest-Rates / Quantitative Easing Sep 05, 2012 - 05:17 AM GMT

By: InvestmentContrarian

Interest-Rates

Sasha Cekerevac writes: In his recent speech at the Jackson Hole economic symposium, Federal Reserve Chairman Ben Bernanke made some interesting comments in regards to monetary policy. Following these remarks, gold moved up strongly, indicating that the market’s interpretation was that the Federal Reserve was indeed going to enact further stimulative monetary policy, also known as quantitative easing #3 (QE3). However, I don’t think it’s clear from the speech or recent events as to why now is the best time to use this monetary policy tool.


On the one hand, the Federal Reserve chairman did outline several reasons not to enact further monetary stimulus. This includes, the text reads, “the use of nontraditional policies involves costs beyond those generally associated with more-standard policies. Consequently, the bar for the use of nontraditional policies is higher than for traditional policies.”

The costs associated with additional nontraditional monetary policy actions by the Federal Reserve are rising and the benefits are diminishing, this we all know. As the Federal Reserve chairman then stated, the bar for using said policies is set higher. So what this could mean is that it takes more stress, such as another financial crisis, to enact further monetary policy action. As of today, we are certainly not in a financial crisis as we were several years ago. At that time, there was a massive liquidity crunch and the Federal Reserve appropriately acted by allowing monetary policy to ease and reduce the stress level. Currently there is no liquidity crunch. In fact, it is the exact opposite: there is more than enough money in the system. Adding $500 billion won’t help increase the velocity of money.

The Federal Reserve chairman then went on to state that monetary policy can’t fix fiscal imbalances. This is a clear message to Congress that the Federal Reserve cannot have an impact on its jurisdiction, namely the budget, tax policies, and business regulations. Again, would another $500-billion stimulus injection help solve the fiscal cliff or improve the tax system to give more incentives to businesses? Of course not.

The Federal Reserve chairman is obviously aware of all of this information regarding monetary policy; however, at the end of the same speech, he states, “Taking due account of the uncertainties and limits of its policy tools, the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions.” This sounds as if the Federal Reserve chairman is stating that while he’s aware of the possible problems, he’s seriously considering taking additional monetary policy action.

I think the best course is for the Federal Reserve to not take any more monetary policy action at this moment. The reason is that there are so many possible potholes over the next few months that the Federal Reserve should keep an ample supply of monetary policy ammunition on hand for a real crisis. Look at the volatility index (VIX); it certainly is not signaling a crisis right now. While the economy and jobs are not growing at a fast rate, they’re also not plummeting.

While Europe is in bad shape, what happens if it were to really fall apart and banks worldwide started collapsing? Now that is a financial crisis that would need the help of the Federal Reserve and a lot of monetary policy action to avert disaster. A situation like that could very well happen in the near future. For the Federal Reserve to use monetary policy action now would mean an even more diminished return during a real crisis.

Source: http://www.investmentcontrarians.com/debt-crisis/why-the-fed-should-not-do-qe3/596/

By Sasha Cekerevac, BA
www.investmentcontrarians.com

Investment Contrarians is our daily financial e-letter dedicated to helping investors make money by going against the “herd mentality.”

Copyright © 2012 Investment Contrarians- All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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