When Ben Bernanke announced last week that the Federal Reserve would embark on potentially unlimited quantitative easing, the markets rallied in celebration. But the party is already coming to a close. Investors are increasingly nervous about the unintended consequences of printing more money. Meanwhile, Guido Mantega, Brazil’s finance minister, has accused the US of starting a “currency war”.
The case for QE3 rests on a combination of weak economic data and dangerous policy inaction. Despite an increasingly anaemic labour market, Congress is failing to stimulate the economy and address the “fiscal cliff” of expiring tax measures and planned spending cuts, which could plunge the US back into recession. On balance, Mr Bernanke’s decision to buy the politicians more time to fix the economy was right.
But the Fed is yet to persuade investors that this policy will deliver. First, as the economy is administered its third dose of QE, the medicine may have become less effective. As diminishing returns kick in, Mr Bernanke is having to push the economy further into uncharted waters just to make monetary policy work.
Second, there are potential longterm risks. Inflation may be under control for now, but as more money is pumped into the economy, there is a risk that prices may creep up in future. Also, some
worry that the Fed will not be able to implement its exit strategy when the economy recovers. Finally, by easing the pressure on Congress, QE3 may give politicians an excuse not to resolve their stand-off over fiscal policy.
For all these reasons, Mr Bernanke is in the line of fire domestically. But pressure from abroad is mounting too. The announcement of QE3 has weakened the dollar, as investors leave the US to seek higher interest rates abroad. As a result, foreign currencies are under pressure to appreciate.
Central banks across the world, most notably the Bank of Japan, eased monetary policy this week to reduce this pressure. But, as Mr Mantega’s remarks show, the rhetoric is becoming vicious. Emerging markets fear that their exports will become less competitive. “Hot money” flowing into the countries could lead to a credit binge. This is what happened in 2008, when the Fed launched QE1.
But emerging economies’ concerns over the impact of QE3 are overstated. Because of slower growth, countries such as Brazil are less appealing to investors than they were in 2008. This should limit QE3’s adverse impact.
Mr Bernanke has shown commendable bravery in compensating for Congress’s inaction. But his aggressive policy stance will not work forever. US politicians would be foolish not to use wisely the time the Fed has bought them.
The case for QE3 rests on a combination of weak economic data and dangerous policy inaction. Despite an increasingly anaemic labour market, Congress is failing to stimulate the economy and address the “fiscal cliff” of expiring tax measures and planned spending cuts, which could plunge the US back into recession. On balance, Mr Bernanke’s decision to buy the politicians more time to fix the economy was right.
But the Fed is yet to persuade investors that this policy will deliver. First, as the economy is administered its third dose of QE, the medicine may have become less effective. As diminishing returns kick in, Mr Bernanke is having to push the economy further into uncharted waters just to make monetary policy work.
Second, there are potential longterm risks. Inflation may be under control for now, but as more money is pumped into the economy, there is a risk that prices may creep up in future. Also, some
worry that the Fed will not be able to implement its exit strategy when the economy recovers. Finally, by easing the pressure on Congress, QE3 may give politicians an excuse not to resolve their stand-off over fiscal policy.
For all these reasons, Mr Bernanke is in the line of fire domestically. But pressure from abroad is mounting too. The announcement of QE3 has weakened the dollar, as investors leave the US to seek higher interest rates abroad. As a result, foreign currencies are under pressure to appreciate.
Central banks across the world, most notably the Bank of Japan, eased monetary policy this week to reduce this pressure. But, as Mr Mantega’s remarks show, the rhetoric is becoming vicious. Emerging markets fear that their exports will become less competitive. “Hot money” flowing into the countries could lead to a credit binge. This is what happened in 2008, when the Fed launched QE1.
But emerging economies’ concerns over the impact of QE3 are overstated. Because of slower growth, countries such as Brazil are less appealing to investors than they were in 2008. This should limit QE3’s adverse impact.
Mr Bernanke has shown commendable bravery in compensating for Congress’s inaction. But his aggressive policy stance will not work forever. US politicians would be foolish not to use wisely the time the Fed has bought them.
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