Friday, October 8, 2010

What Will Additional Fed Easing Do?

Financial FAQs

The Federal Reserve is contemplating additional stimulus measures, called Quantitative Easing (QE2), in a bid to keep economic activity from sinking further. The main reason is their fear that we could end up in a Japanese-style deflationary spiral, when both wages and prices fall.

New York Fed Prez William Dudley spelled out their reasoning:

“Currently, my assessment is that both the current levels of unemployment and inflation and the timeframe over which they are likely to return to levels consistent with our mandate are unacceptable. In addition, the longer this situation prevails and the U.S. economy is stuck with the current level of slack and disinflationary pressure, the greater the likelihood that a further shock could push us still further from our dual mandate objectives and closer to outright deflation.”

Banks are now sitting on more than $1 trillion in excess reserves—i.e., reserves in excess of what they need to keep at the Federal Reserve, and the Fed wants them to begin to lend that money to businesses who want to expand.


Why the huge reserves? It wasn’t because banks were waiting to see the new consumer regulations in the Dodd-Frank Wall Street Reform Act that became law in July, but because there just isn’t enough demand for their business. Large corporations are sitting on mountains of cash because of record profits—from $1 to $2 trillion, depending on who is doing the calculations—and consumers are reducing their debt load because of diminished incomes.

Will additional QE2 cause unacceptable inflation? Not so, according to the inflation indicators. The Personal Consumption Expenditure indicator measures the most general price levels and it currently shows falling inflation, though not yet outright deflation.


The latest numbers are why the Fed worries that inflation is too low. Year-ago headline PCE inflation held steady at 1.5 percent.  Year-ago core PCE inflation was unchanged at 1.4 percent.  These numbers are either at or below the bottom of the Fed’s implicit inflation target of 1-1/2 to 2 percent.  Some Fed officials are now describing the “desired” range as 1-3/4 to 2 percent.

The Fed says it will begin purchasing more long term Treasury securities in order to keep interest rates low. It just purchased $5 billion at the latest Treasury bond offering, for instance. What would so-called ‘QE2’ accomplish? Fed Chairman Bernanke says,

“For a sustained expansion to take hold, growth in private final demand--notably, consumer spending and business fixed investment--must ultimately take the lead. On the whole, in the United States, that critical handoff appears to be under way...(but) the pace of that growth recently appears somewhat less vigorous than we expected. ... Incoming data on the labor market have remained disappointing. ... Overall, the incoming data suggest that the recovery of output and employment in the United States has slowed in recent months, to a pace somewhat weaker than most FOMC participants projected earlier this year.”

In other words, the Fed is trying to find ways to encourage more hiring. The latest Small Business Lending Bill provided $30B in SBA loans + other provisions to businesses with less than 500 employees. Community banks with less than $10B in assets are eligible to administer the funds.

Additional access to capital will be provided by increasing certain SBA loan limits.  The maximum SBA guarantee on 7(a) loans is increased to 90 percent, and fees for 7(a) and 504 programs are temporarily eliminated.  Also, maximum loan amounts are increased:  Section 7(a) loans from $2 million to $5 million; Section 504 loans from $2 million to $5 million; and SBA microloans from $35,000 to $50,000.   The SBA Express program limitation would be increased from $350,000 to $1 million for one year.

One interesting employment statistic for overall hiring is the monthly JOLTS (Job Openings and Layoff Turnover Summary) put out by the Labor Dept. August’s numbers say that approximately 4.20 million jobs were lost, and 4.14 million created in the month. Its most important component is the number of job openings, which has been rising of late. There were 3.2 million openings in August, with the number of job openings up by 863,000 (37 percent) since the most recent series trough of 2.3 million in July 2009, according to JOLTS.


Therefore we should see a private sector pickup in hiring. It means some businesses will be adding jobs—particularly in the service sector (e.g., retailers and restaurants for the holidays). Challenger and Gray expects a 600,000 retail jobs increase this season, up 20 percent from last year’s 501,400.

Harlan Green © 2010

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