To QE3 or not to QE3?

JP Morgan AM’s Tom Elliott says the effectiveness of quantitative easing may have run its course.


The argument in favour of a further round of QE is that economic activity is weaker than it should be at this stage in the cycle, that lower Treasury bond yields are necessary to reduce the cost of credit, and that a new programme of QE will do this and supply further liquidity (read credit growth) to the economy.

Against a back ground of recently poor data from the housing market, where we are seeing prices fall once again, and the labour market where we saw just 54,000 new jobs created in May against around 200,000 in previous months, this argument has some resonance.

But there are several counter arguments, which taken together make us sceptical of a QE3 programme.

First, the macro economic conditions are very different from what they were at the launch of the previous QE programmes. There is little fear of deflation, while GDP growth estimates (Bloomberg consensus) for this year are still firmly positive, at 2.6% and 3% for 2012, if less than what we would have expected to see at this stage in the economic cycle.

Second, it is unclear who would benefit from a further reduction in bond yields bearing in mind the low demand for credit by corporate and the household sector, which is still struggling to repay debt taken on in the previous decade.

Third, there are some unintended consequences of the previous QE programmes that need to be better understood before more money is put into the economy.

One of the causes of weak discretionary consumer demand, which is higher food and energy costs, may be the indirect consequence of the previous QE programmes. ‘Leakage’ of the money may well have contributed to growth and to increased demand for commodities in the emerging economies.

There is also some speculation that Fed policy may have reduced the urgency for fiscal reform.
This is not to say that QE has failed: the US authorities, in line with other governments and central banks, probably avoided a global depression and certainly rescued financial markets through their intervention (see chart). But its effectiveness may have run its course.


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