Why QE3? Fed Right to Focus on Other Things

Jackson Hole and Federal Reserve Chairman Ben Bernanke's speech there,
attention has shifted to this month's Federal Open Market Committee
and the debate over QE3 -- a third round of so-called quantitative
easing.

Given the weakness of the recovery, volatile financial markets and the
headwinds from fiscal austerity, why wouldn't the Fed engage in
another round of easing? After all, QE2 was initiated last year when
the recovery and global financial markets were less fragile.
The Federal Reserve is considering a third round of quantitative easing.

QE3 is not a done deal and could prove to be ineffective despite the
current economic weakness. More and more, monetary policy (especially
quantitative easing) appears ill-equipped to provide support for the
fragile recovery.

Consider these factors:

QE2 remains controversial, and its timing was better: It is always
difficult to isolate cause and effect in an environment as tumultuous
as this global economy, so QE2 remains controversial. Unlike the first
set of actions the Fed took in 2007 and 2008 to stabilize the global
financial system, the impact of QE2 is more muddled. Clearly, the
dollar depreciated, equity markets improved and inflationary
expectations (and retail price movements) increased. It is also clear
that economic activity did not accelerate, commodity prices increased
further and overseas central banks had to respond to the Fed's
actions. In today's environment, retail price pressures are more
prevalent (and not deflation), the dollar is already weak and interest
rates are at modern lows. From the standpoint of interest rates, Fed
statements over the past few weeks have accomplished what QE3 would
do, namely bring down rates. So what else QE3 would accomplish
(besides a temporary bump in equity prices) is something that is not
clear at this juncture.
The Fed still has options, but ... : The Fed's actions since the
beginning of the crisis have been unprecedented, including aggressive
rate cuts, asset purchases totaling almost $3 trillion and a
willingness to provide liquidity to financial and nonfinancial
institutions. Yet there comes a point where monetary policy is pushing
on a string, and the Fed is probably past that point. Liquidity is no
longer an issue. Financial institutional balance sheets have improved
considerably and households have begun the long journey of rebuilding
balance sheets. In addition, remaining committed to its current
accommodative stance through 2013 is a bold action in support of the
recovery. Maybe the time has come to stay on the sidelines for a time
and let other policy solutions support the recovery?

Fiscal policy in the U.S. and Europe matters more than the Fed:
Support for the recovery is not a monetary policy issue. The focus
should be on fiscal policy and the need to provide support in the
short term and a credible plan to address debt levels over the
intermediate to long term. One concern with the Fed repeatedly
intervening is to shift the focus away from where the policy issue
sits -- namely in Washington and European capitals. Enhanced
confidence levels stemming from stronger fiscal policy would have a
more substantial impact on the recovery than QE3 or any other measures
the Fed can bring forward.

QE3 may not be a done deal at this point, and if it does not come to
pass, it will certainly not be the end of the world.

And perhaps the focus will shift to where it should be: the next round
of fiscal negotiations