US Fed chair may face tough sell on quantitative easing

By Ma Xiaoning  (People's Daily)

16:33, August 29, 2011

Edited and Translated by People's Daily Online 

On Aug. 26, the annual meeting of the Federal Reserve was held in a small city in the U.S. state of Wyoming named Jackson Hole. According to U.S. public opinion, the theme speech made by the Chairman of the Federal Reserve Ben Bernanke would be one of the most important news items this week. 

In August 2010, at the same site and the same meeting, Bernanke signaled that if the U.S. economy continued to worsen, the Federal Reserve would launch a securities purchase plan of 600 billion U.S. dollars, which is known as the second round of quantitative easing measures or QE2 for short. The U.S. stock market immediately changed from a bear market to a bull market. 

In November 2010, QE2 was officially launched. The current U.S. economic situation is similar to what it was one year ago. The U.S. economy almost stopped growing in the first quarter, the shadow of economic depression showed in the second quarter, and then the European debt crisis started to spread and the global economy started to face an uncertainty. 

In the policy meeting held in the beginning of August, the Federal Reserve had markedly lower expectations for U.S. economic growth and opened the door for launching another quantitative easing policy. The historical similarity has led to speculative guesses in the market in the past weeks, with many believing that Bernanke will imply during the annual meeting that new stimulus policies, especially the securities purchase plan regarded as a third round of quantitative easing, or QE3, will be launched in order to aid the ailing U.S. economy. 

Most economists believe that there are many factors to push Bernanke to put forward new easing policies. First is the potential threat of inflation. The biggest concern of the Federal Reserve in 2010 was whether the United States would suffer inflation, and in 2011, the already-rising inflation index worries the United States the most. 

Currently, although commodity prices are low, the prices of food, clothes and other goods on the U.S. market are growing because prices of goods from overseas are rising. QE3, once introduced, would certainly further prop up asset prices and generate inflation. 

Second, there is uncertainty about the prospects of the U.S. economy. Although recent employment and real estate statistics are frustrating, there are also good aspects in the economy. The U.S. Department of Commerce report on Aug. 24 showed that the orders for durable goods rose by 4 percent in July, the largest increase since March 2011. The growth has alleviated investors' concern that the US economy may fall into a second recession. 

Third, voices against QE3 can be heard within the Fed that question the stimulus effect of massive bond purchases on the U.S. economy. The St. Louis Federal Reserve Bank president said in an interview that in the event of economic deterioration, the Fed might buy bonds, but now is not the right time. 

All these factors show that the background of the Federal Reserve's annual conference this year is very different from that of last year, which greatly reduces the possibility that Bernanke may put forward QE3. It is believed that Bernanke may propose several alternatives, and the most likely proposal would be to extend its maturing securities. Although such a measure cannot produce dramatic effects on the market like QE3, it can help build a financial environment favorable to economic growth. 

However, even such a mild approach entails risks. First, the market may not cooperate. When the Fed carried out its Treasury bond-buying program of 600 billion U.S. dollars, the Treasury yields rose, not fell. Second, the Fed's current balance sheet is expanding, which will make it harder to implement an exit strategy. Third driving down the yield curve will have an adverse effect on banks, insurance companies and pension funds. Lastly, such a mild measure is also likely to spur inflation. 

Neither the Federal Reserve nor Bernanke has developed any effective measure for boosting the U.S. economy. A problem is that people have become too dependent on the Federal Reserve since its introduction of several major policies for solving the 2008 global financial crisis. As a result, Bernanke's remarks are bound to exert a noticeable impact on the market, no matter whether or not he will take any action. 

There is a vivid metaphor for the Federal Reserve's plight: if the U.S. economy were a slow low-flying plane, the Federal Reserve would be its pilot. Any measure taken may bring good results, or lead to over-interpretation by the market. Overall, overly loose monetary policy may be easily seen as a signal that the Federal Reserve is deeply pessimistic about the current economic situation.

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