QE3: Sowing the Wind
QE3: Sowing the Wind
Friday, September 21, 2012
by Frank Shostak
The US central bank announced on Thursday, September 13, 2012, that
it will expand its holdings of long-term securities with open-ended
purchases of $40 billion of mortgage debt a month as it seeks to boost
economic growth and reduce unemployment.
In his press conference, following the conclusion of a two-day
meeting of the Federal Open Market Committee (FOMC), the chairman of the
Federal Reserve Board Ben Bernanke said the US central bank will
continue buying assets, undertake additional purchases and employ other
policy tools as appropriate if the outlook for the labor market does not
According to the Fed chairman, purchases of housing debt should help
the housing market, which he called "one of the missing pistons in the
engine." Bernanke holds that mortgage-backed securities purchases ought
to drive down mortgage rates and create more demand for homes and more
Some experts are of the view that the Fed could eventually buy more
than $1 trillion in debt given the open-ended nature of its new policy.
The latest Fed policy is based on the work of Columbia professor of economics Michael Woodford
regarding the policy options of the central bank when interest rates
are near zero. Woodford argues that the best way to defeat stubborn
economic weakness is to keep monetary policy very loose for longer than
would otherwise be advisable.
According to this way of thinking the open-ended purchases of
securities should help bolster the confidence of American consumers and
businesses by showing that the central bank is determined to stop the
economy from weakening. This, according to Bernanke (echoing Woodford),
will make people more willing to invest, hire, and spend.
Note that what we have here is a suggestion of how to boost the
demand for goods and services, which is seen as the stumbling block for
the economic expansion. All that is required here is somehow to convince
consumers and business that the Fed has the tools and the knowledge to
revive the economy and strengthen the labor market.
Even if Woodford is right and from now onward consumers and
businesses will be willing to boost their demand because they believe
that the Fed is determined to stop the economy from weakening, this
still may not work. We suggest that it is not enough to boost demand as
such; what is required is the strengthening of effective demand.
People's demand must be fully backed up by previously produced goods and
According to James Mill,
When goods are carried to market what is wanted is somebody to buy.
But to buy, one must have the wherewithal to pay. It is obviously
therefore the collective means of payment which exist in the whole
nation constitute the entire market of the nation. But wherein consist
the collective means of payment of the whole nation? Do they not consist
in its annual produce, in the annual revenue of the general mass of
inhabitants? But if a nation's power of purchasing is exactly measured
by its annual produce, as it undoubtedly is; the more you increase the
annual produce, the more by that very act you extend the national
market, the power of purchasing and the actual purchases of the nation….
Thus it appears that the demand of a nation is always equal to the
produce of a nation. This indeed must be so; for what is the demand of a
nation? The demand of a nation is exactly its power of purchasing. But
what is its power of purchasing? The extent undoubtedly of its annual
produce. The extent of its demand therefore and the extent of its supply
are always exactly commensurate.
In order to boost the demand for goods and services, one must boost
the production of goods and services. For instance, an individual can
exercise his demand for bread by producing shirts; or a butcher can
exercise a demand for potatoes by first producing meat that he can
exchange for potatoes.
Furthermore, producers of final goods can also exchange them for
various other goods such as tools and machinery in order to expand and
enhance the existent infrastructure, which will permit an expansion of
final consumer goods that promotes people's lives and well-being.
The Bernanke-Woodford plan, which is based on relentless monetary
pumping, will lead to a weakening of the economy's ability to generate
final goods and services in line with consumers' preferences. This will
diminish rather than strengthen effective demand for goods and services.
Regardless of psychological disposition, if the ability to generate
final goods and services diminishes, it is not possible to boost overall
demand for goods and services. We could convince individuals that the
Fed's monetary pumping is going to revive the economy and therefore that
it is in their own interest to start buying more goods and services.
However, if the backup is not there — i.e., if there isn't an increase
in the production of real wealth (final consumer goods and services) —
it is not going to be possible to expand the overall demand.
If a baker has only saved ten loaves of bread, he can only exercise
his demand for other goods in accordance with the exchange value of the
ten loaves of bread. In order for him to raise his demand he must
produce and save more bread.
The question that one needs to ask is why after lowering interest
rates to zero and pumping over $2 trillion into the monetary system the
economy remains subdued.
Most economists and other experts respond that we are currently in a
unique situation brought about by various mysterious shocks. It is held
that if it were not for the Fed's aggressive monetary pumping the
economy would have suffered a massive economic depression by now:
contrary to various critics, Bernanke's policy has, if anything, saved
the economy and hence has been very effective.
(The Fed chairman however is of the view that at this stage the
effectiveness of monetary policy might be diminishing. He holds that we
now require some support from fiscal policy. In particular Bernanke
warned that US economic recovery could be in jeopardy if lawmakers can't stop automatic year-end spending cuts and tax hikes from
taking effect. The Fed chairman holds that the new central-bank
stimulus efforts would not be enough to protect the economy from the
We hold that it is a fallacy to suggest that Bernanke's monetary
pumping has prevented the US economy from falling into a severe
depression. What Bernanke's policy has done is to prevent the removal of
various non-productive, wealth-destroying activities that emerged on
the back of previous loose monetary and fiscal policies.
Obviously, if Bernanke hadn't stepped in with massive pumping, a
large amount of bubble activities would have been liquidated by now.
This would have provided more real wealth to wealth generators and would
have set in motion a genuinely solid economic expansion. This would
have strengthened the economy's ability to generate real wealth.
By introducing another massive monetary-pumping scheme Bernanke is
running the risk of inflicting more damage to the process of real wealth
generation. Consequently, this raises the likelihood that we could
remain in depressed economic conditions over a prolonged period of time.
It must be realized that the damage inflicted on the economy by
reckless monetary and fiscal policies cannot be fixed by further
aggressive monetary pumping and by lifting people's confidence in the
Fed's policies. What is needed to revive the economy is to stop the Fed
and to cut government outlays to the bone.
Summary and Conclusion
The US central bank announced last Thursday that it will undertake
open-ended purchases of $40 billion of mortgage debt per month until the
labor market improves substantially. Fed chairman Ben Bernanke, who has
introduced the new policy, is of the view that this will revive the
economy. It is questionable why all this pumping should revive the
economy given that the zero-interest-rate policy and the over $2
trillion in monetary pumping since 2008 haven't been successful. We
suggest that by introducing further massive monetary pumping Bernanke is
running the risk of severely damaging the US economy. Consequently,
this raises the likelihood that the US could remain in a depressed
economic state for a prolonged period of time.
Frank Shostak is an adjunct scholar of the Mises Institute and a frequent contributor to Mises.org. His consulting firm, Applied Austrian School Economics, provides in-depth assessments and reports of financial markets and global economies.
Copyright © 2012 by the Ludwig von Mises Institute. Permission to
reprint in whole or in part is hereby granted, provided full credit is
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