"Just do it. That's the message for the Federal Reserve as it decides this week if it should be to start scaling back on the $85bn in newly minted electronic money it is chucking at the American economy each month.
Wall Street thinks – and hopes – an announcement this week is unlikely. Financiers have enjoyed the Fed's gigantic monetary experiment. They have exchanged Treasury bills and mortgage-backed securities for cash, which they have used to play the global markets.
Main Street has not done so well out of the Fed's QE programme. Indeed, by helping to generate speculative increases in commodity prices QE has squeezed disposable incomes and done as much harm as good.
Back in September, the US central bank bottled a decision to wind down the programme and the markets believe the Fed will find an excuse for delaying again. March is now thought to be the time for tapering to begin. By that time, the new chairman of the Fed,
Janet Yellen, will have her feet under the table. There may be stronger proof from the labour market by the spring that the world's biggest economy is on the mend.
In truth, this Wednesday is as good a time as any for the Fed to make a start on its taper. The US
economy is recovering; QE has been of questionable use; there are long-term risks in keeping the programme in place for too long; the financial markets are calm. The reasons for further delay are not especially good ones.
The decision the Fed is making this week is not about whether to tighten policy. It is not even about removing the stimulus. It is about reducing the amount of stimulus, bit by bit. The Fed will probably start by cutting its asset-buying programme by $10bn a month. The difference will be imperceptible, not least because the judgment on QE will be that it was worth a try and helped initially to put a floor under the economy but has delivered less than promised.
Commendably, the US authorities took a suck-it-and-see approach when the economy was in free fall in the winter of 2008-09. They experimented with zero
interest rates, the troubled asset recovery programme (Tarp), forbearance in the real estate market, a fiscal stimulus and QE. Some of these ideas worked well, some – like QE – not so well.
The minutes of the Fed's policy-making committee meeting in October show that even officials at the central bank have started to wonder whether the QE cost-benefit analysis stacks up. They suggest it might be "appropriate to begin to wind down the programme before an unambiguous further improvement in the outlook was apparent". Why? Because of "concerns about the efficacy and costs of further asset prices".
The Fed is worried about throwing good money after bad, worried that QE is distorting investment decisions and leading to the misallocation of capital, and worried about the losses it would make on behalf of the American taxpayer if there happened to be a sharp fall in the price of the bonds and securities it has bought in the past five years.
The argument against an immediate taper is that the US economy is too fragile to cope with the shock – real or psychological – of a cutback in the scheme.
It is true that by historic standards, the current recovery in the US is no great shakes, but it now looks well established. Interest rates have been low for the past six years and bank balance sheets have been cleaned up by the removal of toxic assets. What's more, even the biggest downturns will come to an end sooner or later. That ability to bounce back is more pronounced in the US than in other economies.
The reason the recovery is not stronger is simple. Labour's share of national income has fallen steadily in the past three decades, and households accumulated uncomfortably high levels of debt in order to maintain or increase their spending. Since the financial crisis, Americans have been putting their finances back into shape by borrowing less. In theory, the shortfall caused by consumer retrenchment should have been filled by companies investing more because as labour's share of national income has fallen, that of capital has risen.
Profits have been further boosted by the job cuts during the slump. There has, though, been no big surge in investment, even though the Fed's commitment to holding interest rates low for an unspecified period of time should make it more attractive for corporations to spend rather than hoard their cash.
But this makes the case for a more active fiscal policy rather than for QE. It suggests that Barack Obama was too timid with his stimulus package, that cuts in federal spending have been too aggressive and that the budget row between Democrats and Republicans, which led to tax increases in early 2013 and the temporary shutdown of some parts of the government in October, has stifled growth.
The Fed was well aware that trouble was brewing on Capitol Hill when it decided not to taper in September. But the two-year deal agreed last week lifts the threats of further spending cuts and offers the hope of peace on the budget front for the next two years. Fiscal policy – changes to tax and government spending – will be less of a drag on the economy in 2014 than it has been in 2013.
There were, though, two other reasons for the Fed's postponement of the taper. The first was concern about the health of the jobs market; the second was fear that the financial markets would go into meltdown. Back in May, the hint from Ben Bernanke, the chairman of the Fed, that he was thinking about a taper was enough to cause bond and stock markets to sell off.
This has certainly not been a jobs-rich US recovery and participation rates have been falling as discouraged workers have given up hope of finding a job. That has made the fall in unemployment look more impressive than it has actually been. But the rate of hiring has picked up in recent months and that trend should continue into the new year. Meanwhile, the financial markets appear to be a lot more sanguine about the taper than they were in the spring.
If the Fed fears that a taper announcement will drive up interest rates, it should accompany an announcement with a commitment to keep the short-term cost of borrowing low. In truth, the market reaction is likely to be small, while consumer and business confidence may benefit from the impression that America is getting back on its feet. As soon as it has acted once, the Fed will wonder what all the fuss was about. It should get on with it".
Source: Larry Elliott, Economic's editor the guardian
