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Why the Fed's "QE3" Plan Won't Jumpstart the Economy - And What Would

What the country needs is money in the pockets of consumers and a focus on employment.

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That is what happened with QE1 and QE2.  They did not reduce unemployment, the alleged target; but they also did not drive up the overall price level.  The rate of price inflation has actually been lower after QE than before the program began.

Why, Then, Is the Fed Bothering to Engage in QE3?

If the Fed is doing no more than swapping bank assets, what is the point of this whole exercise?  The Fed’s professed justification is that by buying mortgage-backed securities, it will lower interest rates for homeowners and other long-term buyers.  As explained in Reuters:

Massive buying of any asset tends to push up the prices, and because of the way the bond market works, rising prices force yields [or interest rates] down. Because the Fed is buying mortgage-backed bonds, the purchases act to directly lower the cost of borrowing to buy a home. In addition, some investors, put off by the rising price of the bonds that the Fed is buying, turn to other assets, like corporate bonds – which, in turn, pushes up corporate bond prices and lowers those yields, making it cheaper for companies to borrow – and spend.

Those are the professed objectives, but politics may also play a role.  QE drives up the stock market in anticipation of an increase in the amount of money available to invest, a good political move before an election.

Commodities (oil, food and precious metals) also go up, since “hot money” floods into them.  Again, this is evidently because investors EXPECT inflation to drive commodities up, and because lowered interest rates on other investments prompt investors to look elsewhere.  There is also evidence that commodities are going up because some major market players are colluding to manipulate the price, a criminal enterprise.

The Fed does bear some responsibility for the rise in commodity prices, since it has created an expectation of inflation with QE, and it has kept interest rates low.  But the price rise has not been from flooding the economy with money.  If dollars were flooding economy, housing and wages (the largest components of the price level) would have shot up as well.  But they have remained low, and overall price increases have remained within the Fed’s 2% target range.  (See chart above.)

Some Possibilities That Might Be More Effective at Stimulating the Economy

An injection of money into the pockets of consumers would actually be good for the economy, but QE3 won’t do it.  The Fed could give production and employment a bigger boost by using its lender-of-last-resort status in more direct ways than the current version of QE.

It could make the very-low-interest loans given to banks available to state and municipal governments, or to students, or to homeowners.  It could rip up the $1.7 trillion in government securities that it already holds, lowering the national debt by that amount ( as suggested a year ago by Ron Paul).  Or it could buy up a trillion dollars’ worth of securitized student debt and rip those securities up.  These moves might require some tweaking of the Federal Reserve Act, but Congress has done it before to serve the banks.

Another possibility would be the sort of “quantitative easing” first proposed by Ben Bernanke in 2002, before he was chairman of the Fed—just drop hundred dollar bills from helicopters.  (This is roughly similar to the Social Credit solution proposed by C. H. Douglas in the 1920s.)  As Martin Hutchinson observed in Money Morning:

With a U.S. population of 310 million, $31 billion per month, dropped from helicopters, would have given every American man, woman and child an extra crisp new $100 bill per month.