1. BOTH THE U.S. FEDERAL RESERVE AND THE EUROPEAN CENTRAL BANK MADE BIG POLICY COMMITMENTS LAST WEEK. WHAT DID THE FED DO?
The U.S. Federal Reserve launched a program known in the media as “QE3”. The program involves Fed purchase of long-term bonds and is designed to bring down long-term interest rates. The program announced last week is the Fed’s third round of purchasing long-term bonds, thus the name “QE3”.
QE1/2/3 represent big changes in the way that the Federal Reserve usually operates, as the Fed typically focuses on reducing or short-term interest rates. However, short-term interest rates have been close to zero now for 4 years, so the Federal Reserve is focusing instead on reducing long-term interest rates.
Studies of the effects of QE1 and QE2 show that they have been effective in reducing long-term interest rates. And lower long-term rates reduce the cost to firms of investing in new plants and equipment and reduce the cost to consumers of buying homes. This should lead to more firm and consumer spending and economics growth.
2. BUT NOT ALL ECONOMISTS AND POLITICIANS HAVE BEEN ENTHUSIASTIC ABOUT QE3 …
The Republican presidential candidate, Mitt Romney, compared the QE3 program to a “sugar high” and repeated his desire to replace the Fed’s chair, Ben Bernanke.
Some politicians and economists have questioned whether a third round of bond buying will be effective in lowering long-term rates, while others are worried that the monetary stimulus will reignite inflation.
Others, including myself, tend to believe that QE3 is needed given the lingering high unemployment in the United States but is likely to generate only modest increases in economic growth.
3. WHAT DID THE EUROPEAN CENTRAL BANK ANNOUNCE?
Mario Draghi, the President of the European Central Bank, announced late last week that the Bank would buy bonds of several struggling European countries—Spain, Portugal, and Italy. The Bank’s very ambitious goal is to put a cap on the interest rates paid by these governments on their debt and to ensure that all three countries remain in the euro zone.
Since Mr. Draghi’s announcement, global stock markets have rallied and bond markets have calmed considerably.
The Bank’s bond-buying program is, however, conditional on governments requesting the Bank to buy its bonds and on those governments showing progress in implementing new rounds of fiscal and regulatory reforms.
4. SO WILL THIS NEW PROGRAM OF THE EUROPEAN CENTRAL BANK WORK?
It’s a big bold commitment that is exactly what is needed. This is a policy that the Bank should have implemented much earlier in the euro crisis. Mr. Draghi deserves much credit for the strong leadership that he has exhibited in getting all major European leaders to support the Bank’s new commitments.
But here’s where we stand now in both the U.S. and Europe: Both the U.S. and European monetary authorities have made big ambitious policy commitments. Now it’s up to European parliaments and the U.S. Congress to follow through with critical reforms to financial markets and banks, labor markets, regulations affecting businesses, and overall fiscal policy. Monetary policy alone is just not powerful enough to ignite strong growth needed to bring Europe and the United States surging back to full employment.
– Sumner La Croix