The Federal Reserve has just unveiled QE3 – its third round of quantitative easing.
It has some traits in common with the first couple of rounds of QE: from the way it works (the Fed pumps cash into the economy by buying up bonds) to the fact that it comes alongside a commitment to keep interest rates at rock bottom for years (late 2015 now, as opposed to the previous horizon of 2014). QE3 also involves continuing with some financial jiggery-pokery involving the maturities of the bonds, the so-called Operation Twist the Fed started late last year.
The difference this time around is that whereas in the previous two rounds the Fed committed to buying a finite amount of bonds, this time the promise is open-ended. The Fed will buy $40bn of mortgage backed securities for as long as “the outlook for the labor market does not improve substantially”.
The theory is that this will boost economic growth (it’s already boosted asset prices – for instance gold is at its highest value in six months), but as ever there are more questions than answers about the policy.
The biggest one, this time around at least, is over whether carrying out an operation of this size and significance is essentially a political one. The logical chain of deduction for this is simple: there is an election in less than two months’ time. No US president has ever been re-elected with unemployment over 8%. US unemployment is currently 8.1%. The Fed said explicitly that this bout of QE is designed to reduce unemployment.
Elements of the Republican party have pushed for a re-examination of the Fed’s conduct and position if they win the election. Indeed, former US Republican Presidential candidate Rick Perry suggested QE was “treasonous”. The decision to press the button on QE is likely to put the Fed right back in the middle of the election debate.
However, this would not be the first time. Ahead of the 1992 election, the first President Bush aggressively lobbied Alan Greenspan (indirectly, it should be said) to cut interest rates and boost the US out of recession faster. Although Greenspan did eventually cut rates (20 years ago this month, in fact), it wasn’t enough to generate much feelgood factor. Bush lost the election, and never forgave Greenspan, telling an interviewer six years later: “I reappointed him and he disappointed me”.
Here in the UK there are many who feel the Bank of England Governor trod too far into the political sphere ahead of the 2010 election when he appeared to endorse the kinds of austerity policies espoused by the Conservative party.
The problem is that as much as we try to convince ourselves that central banking can operate in a political vacuum, the decisions taken on interest rates and the broader economy have important political implications. And at no time is this more the case than when there is an economic crisis – particularly one which has dragged down interest rates to zero.
It is an enormously difficult path to tread. But the upshot is that in reality there will be three – not two – men involved in the US presidential elections: Barack Obama, Mitt Romney and, rather more reluctantly, Ben Bernanke.
If you want to read more, the Fed’s statement is available here.
This article is also available on the Sky News website.