Sunday, 10 November 2013

Why 'QE' needed in Europe and unnecessary in the US

Two Fed papers last week argue, effectively, that US monetary policy needs to be even looser for even longer. The ECB cut interest rates. The press tell us that the Bank of England is more optimistic on growth, and on falling unemployment but the MPC will re-emphasise its commitment to keep rates low. I think the Federal Reserve in the US should be cutting back its bond purchases, while the ECB should be buying in size. That doesn't mean either is very likely. Far from it, sadly.

The US has high (but falling) unemployment and even higher under-employment. It is also an economy with rising real wages and substantial deficits on both the trade and current account balances. It has low consumer price inflation, however we choose to measure it, and a fair degree of asset price inflation by most measures. The economy is growing, but not fast enough to satisfy the desires of those who want to see unemployment fall faster. Two additional observations: the post-crisis environment has seen historically weak growth in output per worker/hour; and this anaemic recovery  is associated with growing inequality that is likely to be the single biggest factor is US politics in the coming years.

US consumption growth remains strong relative to output (those pesky deficits) but investment remains weak (hence the weak employment and low productivity). Inflation isn't a problem, in either direction (this is not deflation, and real wages are rising). Under-investment should be the focus for policy-makers.  John Maynard Keynes might point out that it is not written in law for total aggregate demand to be at a level which ensures the economy is on a path to full employment, and the public sector should step in. There are obvious problems associated with that, of course - starting with the level of the national debt and  moving on the toxicity of the politics around both the debt level and how to ease fiscal policy.

One thing the doctor might well order, is a policy of currency softness. Grabbing jobs back from overseas, helping domestic products compete better with imports, these are desirable in an economy with a manufacturing base and a need of investment.But QE? Not really. QE has boosted asset prices, but that hasn't done anything to hep investment. . QE has done much to make owners of Picassos and Greenwich mansions happier, but while it has helped direct some investment flows towards corporate bonds (good) it has pushed more towards equities and EM assets and it still isn't clear how that helps US companies raise money for productive investment. TARP did more to help banks lend than QE has done. And a small rise in short-term rates might even  help money flow round the SME sector of the US economy more productively.

QE seems the wrong policy when what is needed is to encourage private sector entrepreneurs and companies to invest in plant, equipment and people in order to boost output, and therefore employment and wages. And that in turn, is what is needed to reverse the widening inequality that unchecked, will become an ever bigger social blight.

Contrast all this with the Eurozone. In many European countries wages and prices are now falling in tandem. The current account surplus is huge, and growing fast. Bank lending continues to contract. Consumption is weak and unemployment terrifyingly high. Youth unemployment should be the single biggest issue in the political debate as an entire generation of voters will at some point realise they have been abandoned by their leaders. The Euro Area problem is that investment is weak but consumption even weaker - overall aggregate demand needs a huge boost.

And then there is the debt... public sector debt levels are too high everywhere and private sector debt levels are too high in several countries. With weak nominal GDP growth, these debt levels will go on growing relative to GDP unless one of three things happen - default reduces the debt, austerity creates a downward spiral of increased savings and falling demand that might at some point find an equilibrium debt/GDP level, albeit at a level of unemployment, real incomes and overall GDP that is too awful to contemplate, or policy-makers breathe some inflation back into the system.

In the Euro Area, QE (buying bonds in substantial quantities through a series of auctions, as the Fed does), would encourage the banking sector to lend more and hold fewer government bonds. That would be a good thing. It might weaken the Euro, which would be a very good thing indeed. It might send asset prices and increase inequality but the Euro Area, unlike the US, has a political system and social structure that can counter this. And if it boosted consumption through wealth effects, then that would be a god thing. A weaker currency, a reduced current account surplus, and a boost to bank lending? Bring it on. With banks encouraged to 'cut assets' (i.e, shrink their balance sheets) it makes sense for the central bank to boost its own balance sheet (at least temporarily) to plug the gap they leave behind. I don't think that's the same thing, at all, as 1920s money printing in Germany.

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