Nouriel Roubini's Global EconoMonitor

Hard to be Easing

The United States Federal Reserve’s decision to undertake a third round of quantitative easing, or QE3, has raised three important questions. Will QE3 jump-start America’s anemic economic growth? Will it lead to a persistent increase in risky assets, especially in US and other global equity markets? Finally, will its effects on GDP growth and equity markets be similar or different?


Many now argue that QE3’s effect on risky assets should be as powerful, if not more so, than that of QE1, QE2, and “Operation Twist,” the Fed’s earlier bond-purchase program. After all, while the previous rounds of US monetary easing have been associated with a persistent increase in equity prices, the size and duration of QE3 are more substantial. But, despite the Fed’s impressive commitment to aggressive monetary easing, its effects on the real economy and on US equities could well be smaller and more fleeting than those of previous QE rounds.

Consider, first, that the previous QE rounds came at times of much lower equity valuations and earnings. In March 2009, the S&P 500 index was down to 660, earnings per share (EPS) of US companies and banks had sunk to a financial-crisis low, and price/earnings ratios were in the single digits. Today, the S&P 500 is more than 100% higher (hovering near 1,430), the average EPS is close to $100, and P/E ratios are above 14.

Even during QE2, in the summer of 2010, the S&P 500, P/E ratios, and EPS were much lower than they are today. If, as is likely, economic growth in the US remains anemic in spite of QE3, top-line revenues and bottom-line earnings will turn south, with negative effects on equity valuations.

Moreover, fiscal support is absent this time: QE1 and QE2 helped to prevent a deeper recession and avoid a double dip, respectively, because each was associated with a significant fiscal stimulus. In contrast, QE3 will be associated with a fiscal contraction, possibly even a large fiscal cliff.

Even if the US avoids the full fiscal cliff of 4.5% of GDP that is looming at the end of the year, it is highly likely that a fiscal drag amounting to 1.5% of GDP will hit the economy in 2013. With the US economy currently growing at a 1.6% annual rate, a fiscal drag of even 1% implies near-stagnation in 2013, though a modest recovery in housing and manufacturing, together with QE3, should keep US growth at about its current level in 2013.

But there is no broader rebound underway. In both 2010 and 2011, leading economic indicators showed that the first-half slowdown had bottomed out, and that growth was already accelerating before the announcement of monetary easing. Thus, QE nudged along an economy that was already recovering, which prolonged asset reflation.

By contrast, the latest data suggest that the US economy is performing as sluggishly now as it was in the first half of the year. Indeed, if anything, weakness in the US labor market, low capital expenditures, and slow income growth have contradicted signals in the early summer that third-quarter growth might be more robust.

Meanwhile, the main transmission channels of monetary stimulus to the real economy – the bond, credit, currency, and stock markets – remain weak, if not broken. Indeed, the bond-market channel is unlikely to boost growth. Long-term government bond yields are already very low, and a further reduction will not significantly change private agents’ borrowing costs.

The credit channel also is not working properly, as banks have hoarded most of the extra liquidity from QE, creating excess reserves rather than increasing lending. Those who can borrow have ample cash and are cautious about spending, while those who want to borrow – highly indebted households and firms (especially small and medium-size enterprises) – face a credit crunch.

The currency channel is similarly impaired. With global growth weakening, net exports are unlikely to improve robustly, even with a weaker dollar. Moreover, many major central banks are implementing variants of QE alongside the Fed, dampening the effect of the Fed’s actions on the dollar’s value.

Perhaps most important, a weaker dollar’s effect on the trade balance, and thus on growth, is limited by two factors. First, a weaker dollar is associated with a higher dollar price for commodities, which implies a drag on the trade balance, because the US is a net commodity-importing country. Second, any improvement in GDP derived from stronger exports leads to an increase in imports. Empirical studies estimate that the overall impact of a weaker US dollar on the trade balance is close to zero.

The only other significant channel to transmit QE to the real economy is the wealth effect of an equity-market increase, but there is some circularity in the argument that QE3 will lead to a persistent rise in equity prices. If persistent asset reflation requires a significant GDP growth recovery, it is tautological to say that if equity prices rise enough following QE, the resulting increase in GDP from a wealth effect justifies the rise in asset prices. If monetary policy’s transmission channels to the real economy are broken, one cannot assume that QE will have a significant effect on economic growth.

 Fed Chairman Ben Bernanke has recently emphasized the importance of an additional channel: the confidence channel, through which the Fed’s commitment to maintaining generous monetary conditions for longer could improve private spending. The issue is how substantial and durable such effects will be. Confidence is fragile in an environment characterized by ongoing deleveraging, macro uncertainties, weak labor-market growth, and a fiscal drag.

In short, QE3 reduces the tail risk of an outright economic contraction, but is unlikely to lead to a sustained recovery in an economy that is still enduring a painful deleveraging process. In the short run, QE3 will lead investors to take on risk, and will stimulate modest asset reflation. But the equity-price rise is likely to fizzle out over time if economic growth disappoints, as is likely, and drags down expectations about corporate revenues and profitability.

This post was originally published at Project Syndicate and is reproduced here with permission.

7 Responses to “Hard to be Easing”

Matt DubuqueOctober 18th, 2012 at 2:07 am

The most direct way to stimulate spending and therefore aggregate demand is through direct cash transfers to the poorest of the poor and our seniors, who spend a FAR higher percentage of their income than the billionaires.

Triple the size of everyone's unemployment check.

Give $5000 to everyone on Social Security.

But the oligarchs would never permit that.


Because the ONLY way the Fed will make money on its trillion dollar Treasury portfolio is through controlled DEflation.

Rocket science to the Americans.

DarkoNovember 13th, 2012 at 9:59 pm

This would be the same as throwing petrol on a fire, the stimulus would be spent on cheap crap as the poor have very little understanding of how to manage money…..thus demand would be short lived, and end up doing more for the Chinese economy rather than yours. The great idiot that is Kevin Rudd (Dudd) did this when he was Aussie PM….in fact he was so stupid he did it twice and each time it was a short burn. Even the IMF stated this was not a sound policy… no that wouldn't work

Joshua Ben NunOctober 18th, 2012 at 5:50 am

We've simply forgotten how to have any other kind of economy than a bubble one. The finance ghosts keep baffling and misleading us, and will continue to do so until some historic crisis–a much worse depression, a war, a revolution, or all three–clears them away. The huge and growing wealth imbalance is the greatest crisis the country has faced since the 1930s-1940s. And there is no force on earth, short of revolution, that will reverse it.

Jesse RocheOctober 23rd, 2012 at 4:58 pm

The problem America and developed economies face is fundamental. Given current resources, we've reached the upper limits of what a consumption-oriented world can sustain. Instead of balancing our almost religious reliance on technological innovation with the need to increase all aspects of human potential, we find ourselves beholden to the overbearing demands of the status-quo (i.e., the global super-rich) to maintain their wealth at all costs. Until this dynamic changes, the global economy and our world, in general, will remain the same: persistent poverty, decreasing living standards for the middle classes, and never-ending conflict over scarce resources. We need to face the fact that we live in a Hansel and Gretel world, and any 4-year old should be able to see this. It's utterly depressing (and absurd) that we can't seem to find a way to leave the temptation of the gingerbread house and find our way out of the enchanted forest.

William J McKibbinNovember 13th, 2012 at 7:14 pm

I am more optimistic for QE3 than for the previous stimulus programs — note that QE3 is different from QE1 (which was essentially a bailout for states) and QE2 (which enabled banks to hoard cash) — QE3 is focused on mortgage-backed securities rather than treasury purposes, which means dollars that will eventually create demand for new mortgage-backed securities — in other words, the government is not funding treasury buy-backs, but rather mortgage-backed security creation, which occurs outside the Federal Reserve Banks (only the Fed can create treasuries, whereas mortgage-backed securities originate outside the Fed) — in my view, QE3 stimulus dollars will find their way rather quickly into new real estate deals across the country — the real estate deal-making created by QE3 will be Main Street focused rather than Wall Street or state focused — moreover, the Fed has promised to continue QE3 until the medicine takes effect — again, I am optimistic that QE3 is the right medicine for today's US economy — thank you for the opportunity to comment…

RKARYANovember 27th, 2012 at 1:46 pm

what happens during recession is that there is a contraction in growth. the growth can be improved through fiscal stimulus and quantitative easing. but fiscal stimulus is possible up to a point as it may threaten the downgrading. then quantitative easing is the only option. the interest rates in this case is pretty low. while growth is still low the fiscal stimulus is withdrawn for subsequent years. the quantitative easing alone can not boost demand as it does not enhance the purchasing power. the quantitative easing US and Europe especially find route to emerging economies and the stock market tend to have rally. but the rally is not responded as the channel of export and the internal demand is already subdued. the market go for a correction in between and watch whether real growth is possible. but when the growth prospects are dim the market remains range bound. india is typical example whose currency is also not stable because of current account deficit. the falling currency also creates risk aversion among the investors especially on the stock market. there is hang on the stock market.

peaceboyAugust 9th, 2013 at 6:51 am

I think all the three questions concerning the United States Federal Reserve’s decision are very relevant. I think the QE3 will not make any change to the America’s anemic economic growth. I think QE1 and QE2 has achieved the goal a little bit. But I am not sure of QE3 will progress or not.
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