Why QE4 Isn't in the Cards
The recent financial turmoil already is fueling speculation about a fourth round of quantitative easing by the Federal Reserve, which would again step in to buy financial assets, boosting prices and repressing volatility. This wishful thinking is unsurprising for markets that have been conditioned to view central banks as their best friend. Yet the Fed is unlikely to oblige any time soon, nor should it.
With policy interest rates floored at zero in recent years, the Fed has used its balance sheet to normalize financial markets and pursue its dual mandate of promoting employment and stable inflation.
The first round, QE1, during the global financial crisis, was aimed at repairing a highly dysfunctional financial intermediation system. QE2, in 2010, was intended to stimulate economic activity. The Fed resorted to additional stimulus, including its QE3 program, as the economy then languished in a low growth, “new normal” equilibrium.
Despite a few hiccups and disappointing economic growth, this string of so-called unconventional monetary measures succeeded in lifting asset prices and kept market volatility in check, turning central banks into close allies of the markets. It was to be expected that the recent vertiginous plunge in equities and other risk assets, along with a spike in volatility, would lead to predictions that a new set of measures was in the offing.
Here are four reasons this is unlikely to happen any time soon, if ever.
First, the Fed now wants to normalize monetary policy, and not venture even deeper into uncharted territory. The first policy consequence of the market rout is to virtually ensure that the central bank won't choose September to carry out its first rate increase in nine years. It also reduces the probability of a December hike, though that remains a possibility because not all the consequences of the recent turmoil are negative for the U.S. economy (for example, lower prices for oil and other commodities, and the decline in market interest rates).
Second, unconventional policies haven't proved as effective as expected in stimulating high and sustainable growth. Indeed, the Fed has repeatedly had to revise downward its projections. Central bankers also have been forced to pay greater attention to the potential for collateral damage and unintended consequences -- including distortion in the financial markets, misallocation of resources and the inadvertent worsening of wealth inequality.
Third, the origin of the financial market dislocation is outside the U.S. this time. The turmoil reflects the generalized slowdown in the emerging world, including China, along with worries that policy makers there have less capacity to respond quickly and effectively. More generally, to echo Raghuram Rajan, the highly respected governor of India’s central bank, there are genuine questions about whether the world's central banks have the ability to continuously intervene in markets, and about whether they should want to.
Finally, having exited the third round of easing in a relatively orderly fashion in October, the Fed would be hesitant to place itself in the same position again -- not only for economic reasons but also because of the political risks involved.
So it's premature to expect the Fed to come to the rescue of the markets via a QE4. And such a step probably wouldn't probably be in the broader interest of the economy at this stage. Markets need to get used to finding their equilibrium with less exceptional help from central banks. We should hope they will be able to do so in the future by relying on better fundamental economic conditions.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
To contact the author on this story:
Mohamed A. El-Erian at firstname.lastname@example.org
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Max Berley at email@example.com