Central bankers would like to be able to get back to business as usual where they change the price of money rather than its quantity. That day seems a long way off on both sides of the Atlantic.
The data this month that changed everything came from the U.S. labor market. September non-farm payrolls fell by 95,000; the creation of 64,000 jobs in the private sector wasn’t enough to compensate for the decline of 159,000 in the public sector. The minutes of the last Federal Reserve meeting, published last week, added fuel to the flames with calls for more action.
The markets have taken all of this as evidence that the Fed will start doing more quantitative easing at its meeting on Nov. 2-3. Stock markets surged and the dollar fell on the news.
I was at the Fed last week in Washington for one of its occasional meetings with academics. Half a dozen labor economists, including myself, met with Fed Board members to discuss the labor market. Of particular importance was a paper by John Haltiwanger, a professor of economics at the University of Maryland, who showed there has been a big decline in the job-creation rate over the past decade. The current obstacle is the lack of credit for small firms.
The Fed is especially concerned about unemployment and the weak housing market. Chairman Ben Bernanke made that clear in his speech last week. It would be a major surprise if the Fed didn’t do more quantitative easing -- creating money by enlarging the central bank’s balance sheet with the purchase of securities -- at its next meeting. Failing to act now with such high expectations may throw the markets into a tailspin.
Out of Question
The economic models are telling us that we need more stimulus. Lowering interest rates and more fiscal stimulus are out of the question. Quantitative easing remains the only economic show in town given that Congress and President Barack Obama have been cowed into inaction.
The major questions about quantitative easing aren’t so much if, but how much will the Fed buy and of what type? There is little point in moving slowly. So $100 billion a month for six months seems a reasonable amount.
What will they buy? They are limited to only federally insured paper, which includes Treasuries and mortgage-backed securities insured by Fannie Mae and Freddie Mac. But they are also allowed to buy short-term municipal bonds, and given the difficulties faced by state and local governments, this may well be the route they choose, at least for some of the quantitative easing. Even if the Fed wanted to, it couldn’t buy other securities, such as corporate bonds, as it would require Congress’s approval, which won’t happen anytime soon.
The Bank of England also seems likely to do more quantitative easing at its next meeting, when it will also publish its latest outlook. Its economic-growth forecast will surely be lowered as business and consumer confidence has slowed in the U.K. over the last few months. Unemployment has started rising and house prices have begun to fall - with the Halifax index dropping 3.6 percent in September.
The probability of the Monetary Policy Committee moving on Nov. 4 will increase if the Fed acts first: These aren’t currency wars but quantitative-easing wars, preventing the U.S. from gaining a competitive advantage and damping further appreciation of the pound against the dollar.
In an important speech, MPC member Adam Posen set out the case for more easing. Others, including Paul Tucker, Martin Weale and Paul Fisher, have made comments that seem sympathetic to restarting the asset-purchase program.
Who’s in Charge?
The new government under Prime Minister David Cameron has made it clear it wants to coordinate monetary and fiscal policy. So Chancellor George Osborne’s intervention at the International Monetary Fund meetings, saying he wanted more monetary easing, came as no surprise before he announces a program of massive fiscal tightening. This raises the question of who is setting central-bank policy. Will Osborne decide the scale, timing and type of assets to be bought? If so, we don’t need an MPC.
In any case, Osborne does have the power to change any decision he doesn’t like if he considers it in the national interest under the Bank of England Act - such as raising interest rates. So the MPC is now under the chancellor’s thumb, which may be a resigning matter for some. I certainly would not have taken to being told what to do.
When I was a member of the MPC, we first asked the Treasury for permission to do so as we needed to insulate the Bank’s balance sheet. Chancellor Alistair Darling then wrote back and agreed to QE up to a fixed amount, leaving the details of the speed, scale and type of purchases up to the MPC. We asked him rather than the reverse.
Central bankers yearn for the days when they used to meet to decide on the price of money by setting interest rates. It is hard to see when those times will return.
(David G. Blanchflower, a former member of the Bank of England’s Monetary Policy Committee, is professor of economics at Dartmouth College and the University of Stirling. The opinions expressed are his own.)
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