Bernanke’s “Hail Mary”

Bernanke’s “Hail Mary”

Check out the following commentary by Economics Finance blog contributor Justin Temple

Article Links:
http://online.wsj.com/article/SB10001424052748703506904575592471354774194.html?mod=WSJ_hp_LEFTWhatsNewsCollection

http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm

http://www.tradingeconomics.com/Economics/GDP-Growth.aspx?Symbol=USD

After months of controversy, Fed Chairman Ben Bernanke this week announced a second round of quantitative easing, fondly referred to as “QE2.” This bold and risky maneuver is considered by many to be a “Hail Mary” pass by the Fed. Will this Hail Mary be completed and result in a stimulated and prosperous economy or can we consider this play a “bargain with the devil” as it has been referred to by Thomas Hoenig, president of the Kansas City Fed and lone dissenter in the vote for this policy?

The U.S. economy is officially considered to be out of the recession; however, we are still experiencing continued slow recovery. This is numerically evident with an unemployment rate of 9.6 percent, the number of unoccupied homes exceeding 14 million, and the fact that manufactures are operating with 28 percent of their productive capacity going unused. Furthermore, while real GDP growth has increased from 1.7 percent to 2.0 percent from the second to the third quarter of 2010 respectively; it is still far below the U.S. average of 3.31 percent since 1947. These numbers are disappointing, yet impersonal and generalized. The real effects of slow growth in the economy are being felt by our citizens: individuals looking for work, families struggling to feed their children, people being unable to sell or buy homes. We are “officially out of the recession,” but are we really? This is the predominant issue that the Fed has been working to determine a remedy for.

QE2 is their answer.

QE2 is a program developed by the Fed, in which they plan to buy $600 billion of U.S. government bonds over the next eight months in order to drive down interest rates in the economy. The hope is that by injecting the economy with $600 billion, in $75 billion monthly installments, interest rates will decrease and this will encourage more borrowing and growth.

Why does the Fed expect that this will be the result of their program? By the Fed purchasing government bonds, the aggregate affect on the economy will be a decrease in the amount of bonds available and an increase in the amount of money which is used to purchase these bonds. Decreasing the available supply of bonds will increase the price of bonds thus pushing down their yields to maturity (interest rates). The money market is inversely related to the bond market, so by increasing the amount of money available, interest rates are lowered and borrowing becomes more attractive. The Fed hopes that by decreasing interest rates, saving will become less attractive to individuals and businesses, and thus more money will be borrowed now and spent on consumption and investment. An increase in consumption and/or investment will have a net result of increasing real GDP and thus growing our economy at a more acceptable rate.

So, will this most recent attempt to stimulate the economy work? Will it have lasting positive effects? Economists at the research firm Macroeconomic Advisers LLC don’t seem to think so. They have calculated that “even if the Fed purchases $1.5 trillion worth of Treasury bonds - which some economists say remains a distinct possibility - it would only bring the unemployment rate down by 0.2 percentage points by the end of 2011.” It is also important to bear in mind that while monetary policy can have large and beneficial impacts on the economy in the short-run, in the long-run its effects are far less potent.

Do you think that the QE2 will be beneficial to the economy? Will it stimulate short and/or long-term growth?

Do you think that $600 billion is outrageous, or should we be spending more to get the economy back on track?