The economic data out of the United States is eerily reminiscent of Japan in the 1990s, with 10-year U.S. bond yields being at their lowest level in two centuries, negative stock returns for the year, falling oil prices and stagnant job growth.
If the United States is going to avoid having a Japanese-style lost decade, the Federal Reserve needs to act in far more dramatic fashion than it has previously during Ben Bernanke’s tenure.
Asset markets showed that the previous QE2 had a stimulative impact on the economy. However, the program was not sustained long enough and there was no clear signal given to markets as to what, exactly, the Fed was trying to accomplish. Neither was there any indication to how permanent the increase in the money supply would be.
The odds of the Fed instituting another round of quantitative easing QE3 are up to 50 per cent. Since this probability is already baked into current asset prices, the next program will have to be particularly bold if it is to make a difference.
The Fed needs to avoid making the same mistakes it made under QE2. The Fed needs to go a lot further, a lot faster, and be clearer in its intentions. And make no mistake, the Fed can do so, if it wishes. The idea that the Fed has done all it can do is without merit, though under current U.S. laws there are some limitations.
There is some concern that doing so would cause runaway inflation. But where is the evidence for this belief? Inflation hawks warned us in 2009 that low U.S. interest rates would cause a “double digit inflation in the next two or three years.” It didn’t happen, of course, and the market believes it will not happen in the future. Current U.S. inflation is at 2.3 per cent, with the bond market predicting that inflation in the U.S. will average 1.38 per cent over the next decade. U.S. 30 year bonds have yields less than 2.6 per cent, forecasting a three-decade period of very low inflation.
The Federal Reserve needs to announce an explicit goal such as expected nominal GDP growth or Cleveland Fed inflation expectations and commit to continually adjusting the money supply to maintain that level. If Mr. Bernanke is unable or unwilling do so, he needs to resign.
Mike Moffatt is an Assistant Professor in the Business, Economics and Public Policy (BEPP) group at the Richard Ivey School of Business – Western University. Mike also does private sector consulting for the chemical industry and can be found on Twitter at https://twitter.com/#!/MikePMoffatt.