UNEMPLOYMENT REMAINS high, and the stock market has plunged. So it’s understandable that many Americans are looking forward to Federal Reserve Chairman Ben S. Bernanke’s speech to the annual central bankers conference at Jackson Hole, Wyo., on Friday, hoping that he will say or do something — anything — to stimulate the U.S. economy. After all, that’s what Mr. Bernanke did last year at this time, when he announced the central bank’s willingness to undertake a second major round of Treasury bond purchases known as “quantitative easing.” But as difficult as the country’s economic situation may be, the risks of a big, new dose of monetary stimulus might well outweigh the benefits.
The Fed launched its first round of quantitative easing in response to the market crash of 2008. The central bank expanded its balance sheet by more than $1 trillion, mainly by purchasing mortgage-backed securities. This massive exercise in money-printing was a success, in the sense that it helped prevent a sudden deflationary spiral and a global depression.
The second round, known as “QEII,” began in November 2010 and ended in June; its results were more ambiguous. By buying $600 billion worth of Treasury bonds, the Fed prevented deflation from taking hold but did not manage to kick off a self-sustaining growth cycle. QEII helped drive up stock prices as anticipated; that, in turn, created a “wealth effect” that might have persuaded some asset owners to spend more on consumer goods. But the stock market has fallen back to pre-QEII levels now that the program is over.
Given this history, a QEIII might merely succeed in demonstrating the law of diminishing returns. Meanwhile, the core rate of inflation (price increases excluding food and energy costs) has crept up to within striking distance of the Fed’s 2 percent target. Printing more money might push it above that, unleashing dangerous inflationary expectations. The Fed recently promised to continue making funds available to the financial system at nearly zero percent interest. While perhaps necessary in the short run, this policy amounts to a penalty on prudent savers and a reward to over-leveraged debtors. That can’t be good for the economy over the long term. At most, Mr. Bernanke might try to ease credit conditions a bit by swapping the Fed’s maturing short-term U.S. securities for longer-term ones, so as to suppress already-low long-term rates. But even that modest step risks distorting market incentives.
The fact is that cash is not exactly scarce — corporations and banks are awash in it. They just don’t see many profitable opportunities for deploying their money, though the federal government has just reported the first quarterly bank-lending increase in three years — a 1 percent jump during the second three months of 2011. In short, the private sector still hasn’t discovered the next big sources of profits and job creation. And given the huge overhang of U.S. consumer and government debt, Europe’s problems, and continuing instability in the Middle East, it may take time for rapid growth to resume. If only Mr. Bernanke could bring about durable economic recovery by waving a monetary magic wand. But, alas, he can’t.