With policy interest rates close to zero, yields will be clamped. But, even so, the pass-through to consumers will be tenuous for as long as confidence is weak, jobs are scarce, and house prices are falling, suggesting other tools will be needed – especially if the pre-commitment unintendedly just ends up deferring borrowing.
Short of bullets
Though the list of options is shortening, at least three factors suggest the need for extra stimulus. First, rates have been close to zero for approaching three years with no lasting improvement in consumer confidence. Bernanke believes the impact of the $600bn part of QE2 was equivalent to about 75bp off the funds target rate.
So, on the basis that the cumulative $2.6trn in QE (buying of US Treasuries, agencies and mortgage-backed securities) has been equivalent to slicing some 325bp off the funds target rate, the US is running an effective nominal policy rate of not 0.25%, but minus 3% (or minus 5% in real terms)!
Second is the benign inflation outlook. Core inflation should stay low relative to the same stage of most previous US recoveries. Similarly, unemployment – the Fed’s other mandated concern – will be far stickier relative to previous recoveries. September’s rate of 9.1% compares with 5.7% at this stage of recovery from the 2001 recession, and 7% to 7.5% for each of the previous three recessions (1980, 1981-82 and 1990-91). This will drag on inflation. And, getting it down to these levels by November 2012’s elections looks unlikely.
If the Fed is right to have in mind a 5% to 6% ‘non-accelerating inflation rate of unemployment’ (NAIRU), then the unemployment rate would have to fall by at least three percentage points from here before national wage pressures build. This would need a four million unemployment reduction – which at current underlying payroll gains would take four years! And this with real oil prices still suggesting job losses down the line.
Fiscal stimulus
Then, linked to that, is the fiscal side, where there’s now far less room for largesse. Even the agreed $2.1trn deficit reduction over ten years is relative to a planned, ‘base-line’ increase of $10trn. And this has been superseded by Obama’s $447bn jobs package which he hopes can be financed by growth-induced revenue, rather than more debt.
As a result, our policy looseness analysis – of how far from average a country’s monetary and fiscal stance will lie – suggests 2012 will be the fifth year running of abnormally loose policy. This analysis is our own version of the Fed’s Taylor Rule for setting policy rates, but takes explicit account of the fiscal stance and QE. In the long term, it suggests that, even if the Fed was eventually to raise rates to a growth ‘neutral’ 3%, it would still leave intact about two-thirds of the crisis stimulus since 2007.
We’re some way from that of course. And, meantime, with the list of options shortening, the worry should not be that extra policy stimulus is overkill (as some Congressional Republicans believe), but that consumers will be unable to repair their balance sheets when the true (QE-adjusted) policy rate is as low as minus 3%!
