How much "quantitative easing" (QE) does the world need? We're about to find out, as the chairman of the US Federal Reserve will make his much anticipated keynote speech at the central bankers' get-together in Jackson Hole today. In the way of these things, his remarks may be Delphic and infinitely parsed, with as many views on what he "really meant" as there are economists paid to interpret such words.
Then again he may be more than clear about his objectives – as he was this time last year, when he unveiled another bout of QE, some $600bn-worth, quickly dubbed QE2. Some think he may do something of the same again today. I doubt it.
That is not to say that he couldn't do so. A very clever economist vouchsafed to me recently that the only limits to "quantitative easing" was the number of assets in the world that could conceivably be purchased by an ambitious central bank. For that is simply what quantitative easing is. Behind the mysterious high-priest language lies a simple idea: the central bank buys assets, usually government bonds or other commercial securities – to drive up their price and push down the return on those assets. That happens because investors have to spend that much more to buy a government bond that will deliver a given level of income from its fixed coupons, the flow of interest payments that come from it.
When the returns on such assets become ever more paltry, investors are supposed to turn instead to the sort of assets the central bank would like them to buy instead, say bank shares, with their juicy, if illusory, prospective yields (assuming they don't collapse in the meantime). Alternatively, households and businesses could decide that the "safe" returns they receive on their cash savings are so low they might as well go out an depend or invest in their businesses instead, also desirable outcomes.
Yet the central bank could just as easily, though bizarrely, decide to buy houses, or second-hand cars or fresh fish for that matter. On each occasion it would be creating new money to pay for the goods bought, and central banks can create as much money as they wish.
QE is, let there be no doubt, inflationary in intent, because the fear is still of the world relapsing into deflation and depression rather than some sort of runaway inflationary boom. Hence all the chatter about the US Fed, and the Bank of England for that matter, going out and spending even more on asset purchases. The Fed could launch the much-vaunted QE3 with almost unlimited funding. That really would be a shock. There are two good reasons why we won't see much more than the most doveish of words – but no action.
First, each round of QE since the original in the panic conditions of 2008 and 2009 has had a progressively smaller effect, allowing for the different size and timings of the stimuli. The general consensus is that market rates were depressed by about 100 basis points compared with a hypothetical non-QE world for each round of QE – the November 2008 injection of $600bn, the March 2009 run of $1.15trillion, and the November 2010 exercise, worth a further $600bn.
Reducing interest rates by, say, 1 percentage point compared with where they might otherwise be is a more dramatic thing when rates are generally at 5 per cent than when they are at 1 per cent, and because interest rates can't go negative, there are technical limits to the policy in any case. Of course you could well argue – too few do – that the US might be in even worse shape than she is today if those trillions had not been expended. But the fact is that the medicine seems to be having less effect on the patient, and that may be because the disease is more profound than we think.
Look at the big picture for a moment. Is America's problem a lack of aggregate demand in her economy? Yes. Do investors lack confidence and would they be buoyed up if Mr Bernanke announced QE3? Yes; the effect on the Dow and the Nasdaq would be instantaneous and dramatic. Are those challenges America's only economic problems? Of course not.
There is a reason why the US is in the mess it is in, and it is simply that Americans consumed more than they produced for too long, and are even now still doing so. Reluctant as Americans may be to admit it, their economy is uncompetitive, and their living standards have been unsustainable. This over-consumption is cause and effect of the yawning twin gaps – the trade deficit, especially with China, and the Budget deficit. QE – and the various tax cuts and other stimuli – are palliatives to try to raise consumption, at a time when the economic logic is pushing it down. The trade effect is thus improving a little as Americans cut back, though slowly; the budget deficit is not, for well-known political reasons.
Now consider the "confidence building" effects of QE. If stock-market investors are depressed, is the best way to deal with that to repeat the errors of the Greenspan era. For it is perfectly arguable that QE is simply the "Greenspan Put" in another guise – the "Bernanke Put", if you will.
Whereas the former "maestro" of the Fed cut interest rates at the first sign of a stock-market correction, Mr Bernanke must not be panicked into repeating that error. Equity corrections are necessary and desirable if that reflects the underlying outlook for profits, and, even if they are irrational, it is perhaps best not to try to underpin them. The diminishing effectiveness of the Greenspan Put ought to serve as a cautionary lesson for the limits of QE.
We ought also to recall Keynes's famous remark about the usefulness of monetary policy at a time of depression – "pushing on a string". The insight behind that is that low interest rates and creating money won't influence businesses if they are just too downhearted to invest, nor households too fearful to spend. So, if you think you'll lose you job in a few months, you won't want to buy that new Honda no matter how attractive the finance the bank can offer you. If you think there'll be no demand for your delivery service a few months hence, then there isn't much point in buying that new van, again no matter if the bank lets you have the cash almost for nothing.
Besides, QE is, arguably, not really necessary at all given what is happening to market interest rates in any case. Part of this is a perverse reaction to US weakness, and therefore to be treated with some caution. A second recession is so real a possibility that markets have marked in expectations of low rates for a long time to come. They were encouraged in this by Mr Bernanke's last remarks, which pointed to a continuing loose policy. Thus, it bears repeating, monetary policy is extremely easy by any possible standard, probably the most relaxed in American history.
If a unprecedented monetary and fiscal stimuli are prompting such a feeble response in growth, the time might have arrived to reflect some more on how to fix America's economy. That is precisely what the central bankers will be doing in the calm surrounding of Jackson Hole.