Why Do We Need QE3?

Financial FAQs

It’s not hard to see why we need “QE3”, the Fed’s bond buying program to keep long term interest rates low. It’s almost an act of desperation. The Fed is the only game in town to stimulate growth at the moment, when we are teetering on the edge of several ‘fiscal cliffs’.

That is, the private sector is not creating enough jobs on its own to pay down the budget deficit, or maintain a secure social safety net. In fact, the unemployment rate has to fall at least 2 points—close to 6 percent—to bring us near full employment and an economy that returns us to prosperity. The U.S. economy is also dealing with the prospect of another credit downgrade that could endanger our fiscal solvency.

“The stagnation of the labor market in particular is a grave concern not only because of the enormous suffering and waste of human talent it entails,” said Fed Chairman Ben Bernanke at the Fed’s annual Jackson Hole conference, “but also because persistently high levels of unemployment will wreak structural damage on our economy that could last for many years.”

Graph: Calculated Risk

There were just 96,000 payroll jobs added in August, with 103,000 private sector jobs added, and 7,000 government jobs lost. A meager total much below the first part of the year. The unemployment rate decreased to 8.1 percent (from the household survey), and the participation rate declined to 63.5 percent, mostly from the decline in manufacturing employment, which depends on exports which have flagged of late.

The reason for “persistently high levels of unemployment” is not a mystery. Incomes of the 80 percent of wage and salary earners whose spending powers most economic growth have fallen with no relief in sight when productivity gains are soaring. The problem is very little of those gains are flowing to the workers producing those goods and services.

From 1948 to 1973, the productivity of all nonfarm workers nearly doubled, as did average hourly compensation.  Although productivity increased by 80.1 percent from 1973 to 2011, average wages rose only 4.2 percent and hourly compensation (wages plus benefits) rose only 10 percent over that time, according to government data analyzed by the Economic Policy Institute.

That is a lesson that seems to have been lost at least since the 1970s. So until programs that stimulate actual job growth are enacted, there won’t be much more job growth, in spite of the Fed’s best efforts.

What programs are needed? This is also self-evident. Programs that decrease the record income inequality, the worst since the 1920s. And can be government-led, at the moment, without increasing the deficit. That is the misinformation being spread by those who do not understand growth. Romney, Ryan, et. al., don’t seem to realize that spending tax dollars on infrastructure, education, fire, police, healthcare, and the like, are actually dollars spent in the private sector that are deficit neutral. It’s called pay-as-you-go, the congressional rule that any spending increase had to be matched with a revenue increase. This rule that served President Clinton so well and enabled 4 consecutive budget surpluses, was only abandoned in 2000 when the Bush-Cheney administration cut taxes while increasing spending.

The huge inequality gap has reached historical levels not seen since 1928, which has depressed demand for the goods that drive growth. Economic historians such as Professor James Livingston, in particular, have known this. Private investment has been diminishing as a share of GDP since 1900. “So corporate profits do not drive economic growth — they’re just restless sums of surplus capital,” said Livingston, “ready to flood speculative markets at home and abroad. In the 1920s, they inflated the stock market bubble, and then caused the Great Crash. Since the Reagan revolution, these superfluous profits have fed corporate mergers and takeovers, driven the dot-com craze, financed the “shadow banking” system of hedge funds and securitized investment vehicles, fueled monetary meltdowns in every hemisphere and inflated the housing bubble.”

The policies that created such weak payroll numbers cannot be allowed to continue. Fed Chairman Bernanke and his Board of Governors are the only federal officials able to act at a time when our economic health hangs in the balance.

Harlan Green © 2012