Many highly regarded economists have been writing blogs today offering their opinions of Federal Reserve Chairman Bernanke's press conference. Tim Duy, Brad DeLong and Mark Thoma have all come out with the opinion that while Fed forecasts would imply the necessity of further quantitative easing, Bernanke appears to be scared away from action. Encompassed in their view points, as well as the Fed's outlook, is that core inflation is unlikely to reach even 2 percent in the near future and unemployment is likely to remain higher that ideal for several years. Therefore, given the Fed's dual mandate of full employment and stable prices, another round of quantitative easing aimed at reducing unemployment is worth the risk of higher inflation.
If the situation above were definitively true, I would have no reason to argue with any of these economists that are certainly far more intelligent than I. However, the necessary presumption that each of these economist's makes, is that the Fed is capable of bringing down unemployment through quantitative easing. QE, as a matter of policy, has primarily provided banks with low interest-bearing reserves in return for various maturities of interest-bearing Treasury bonds. The primary effect of this policy appears to have been in reducing the risk premium of interest-bearing assets and consequently driving up the prices (down the risk premium) of practically all other asset classes. Considering well established data on the minimal wealth effect from stock prices, an over-leveraged consumer sector and tight controls on credit, it remains unclear that QE had any meaningful effect of job growth.
While the official unemployment number has been decreasing, the total number of Americans employed has been relatively stagnant for several years. Much of the decrease in unemployment has been due to a lower percentage of the population being considered part of the workforce. Even with QE2, job growth has averaged barely 200,000 jobs per month, not much over the 125,000 to 150,000 needed to simply cover growth in the population. We must not forget that during this fiscal year, which encompasses all of QE2, the federal government is expected to run a deficit of nearly $1.5 trillion, or close to 10% of GDP. Economists have often argued that the Fed must step up in response to the federal government cutting back. Although austerity may be coming to America in the near future (for our sake let's hope it doesn't), it has not yet arrived and a 10% deficit is incredibly stimulative fiscal policy. How many jobs were created by fiscal policy is also unclear, but I have a feeling President Obama would like to lay claim to a sizable portion of that job growth.
The question renowned economists therefore should be asking is, "can the Fed have a significant impact on unemployment through QE?" From my perspective, there are ways in which the Fed could encourage greater employment, however QE in it's current state is not one of them. Economists' should also consider the unintended consequences of Fed policy aside from core inflation. To date, the Fed appears very capable of sparking grandiose speculation in financial markets. Yet the Fed has appeared unable to control the specific assets to which that speculation is directed. I fully agree that another round of QE is unlikely to create surging inflation. What remains suspect is whether or not it will generate surging oil and food prices. With wages currently flat-lining in the US, further rises in food and energy costs may incite deflation in other assets, including housing, causing greater economic pain and job losses.
Limiting the discussion of another round of QE solely to the effects of core inflation and unemployment makes two large assumptions that have not been proven true by recent history. An honest discussion must consider the potential for ineffectiveness of the part of the Fed in reducing unemployment and the potential for inducing skyrocketing prices outside the realm of official inflation measures. Although I haven't been the greatest supporter of the Fed or Bernanke during these times, maybe their recognition of these facts has led to the somewhat confusing and contradictory position laid out earlier today. There are many economists and policy makers out there far smarter than I, who can offer greater insight on the merits of QE3. However, I strongly believe that discussion of further action must start with more of an open mind about the potential cause or correlation of past policy with realized events.