If it doesn’t cause any harm,well,…
…let’s carry on then with the same treatment. This is usually a classic when you have tried everything to cure a patient with standard methods and everything fails. Or even more extreme in the House MD variation on this theme :”If it works, we were right, if he dies it was something else”. But all in all, this was the message delivered by Ben Bernanke last Friday in his defense of recent monetary actions :“The cost of nontraditional policies, when considered carefully,appear manageable, implying that we should not rule out further use of these policies if economic conditions warrant”. Basically, Ben is still ready, willing and able to to fill the ammo and fire more grenades.
Let’s start with 3 bird eye view observations on this message. First of all, as a main line of defense, it’s rather poor I think. You usually justify something by stressing the advantages (proven if you please) instead of stressing the absence of disadvantages. Two and logically as is the case with our ill patient, it confirms how little economic science knows or can prescribe for solving crisis situations. Also to that extent, QE experiments are a “long shot”. And hence 3, is it really the case that so far this has caused no negative side-effects for the patient ?
The remaining other justification for Bernanke was the continuous high level of unemployment. Also the European release on Friday was not something to be cheerful about : 11% U-rate with 1 out 4 under age 25 out of work, in some countries even 1 out of 2. Here Bernanke has a point :“Long periods of high unemployment produce enormous human suffering and waste of human talent, and also risk causing structural damage on our economy which could last for many years”. Or to paraphrase Colonel Frank Slade in Scent of a Woman :“I have seen boys like these, their arms and legs ripped off. But there is nothing like a sight of an amputated spirit, no prosthetic for that”. Next question is do we solve this by QE ? Usually labor market evolutions are at best third round effects of some economic measure. Here it should come from lower interest rates, more business loans creating business and hence in the end new jobs. So far not much evidence on this even if we admit that labor markets usually react with considerable time lags (certainly in Europe due to institutional factors such as labor hording and hysteresis). Some might counter this by claiming that in absence of some measures, the labor market drama would even have been worse. May be, but nevertheless, I for one certainly respect the argument of a lost generation and trying everything to soften this, even if it involves nontraditional measures.
Now coming to the absence of negative side effects and managing things, or being in control of the situation. Recently we have been stressing that QE risks overkilling financial markets by destroying bank activity, exactly the opposite it is supposed to do (sucking out high grade collateral). I have 2 more things to add to that
1) In game theoretic terms, QE might be a panacea for others not to implement the necessary reforms or take the necessary measures to get the structural act together. So I hope that if in case of Europe it will be announced next Thursday, it will at least have some conditionality attached to it. Quid pro quo : “I, ECB, make life easier for you (governments and banks) provided you grow up and don’t become too dependent on me. Please confirm in written and signed”. That is probably in essence what Draghi and European politicians are discussing right now to convince the Bundesbank.
2) So far inflationary pressures/expectations are seemingly modest, with the exception of commodities of course. The only thing QE – or disguised QEs such as LTRO – has produced until now is securing some cheap refinancing for banks. In the case of LTRO it probably was necessary because not a lot of maturing bank bonds would have been rolled over to the same investors. Or in case that they did, probably at a funding cost killing financial markets and spurring a new liquidity crisis. So the extra money serving for the roll implies that this extra money not automatically ends up in the real world, moderating inflationary pressures. For now, that is. Once it has effect – through leverage – these price pressures caused by too much money chasing too few goods might create some problems in a couple of years from now. Quid next ? Do we dispose of a plan B or a nontraditional exit plan ? It certainly will be a nontraditional event in view of the trillions of $ and EUR which will have to be taken out of the system. But let’s have some Belpop history having the final word here : “I know the rules, I know the game, but I never played, played this game before”