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by Irwin Kellner
Tuesday, July 26, 2011
Commentary: Monetary policy's all that stands between us and recession
With the economy still weak and the politicians unable to agree on a plan to lift the debt ceiling, it might be time for the Federal Reserve to embark on QE3.
Before you think I have lost my mind, please examine the three facts listed below.
First and most important, the economy — supposedly out of recession for two years — is not in good shape. After rising at a paltry rate of 1.9% in the first quarter, the gross domestic product likely crept ahead at an even slower pace in the second, according to the MarketWatch consensus. This is why the unemployment rate now stands at 9.2% — the highest since the end of last year.
The next fact worth noting is that any agreement to increase the debt ceiling will involve a tightening of fiscal policy. Indeed, such policy has already tightened, since spending by Washington has fallen substantially — enough to cost tens of thousands of federal employees their jobs.
Finally, long-term interest rates have backed up. After dropping to a 52-week low of 2.82%, the yield on the Treasury's ten-year note (^TNX - News) has once again reached 3%. While its yield has been much higher, it has also been much lower and in this economy, lower is better.
If we are to avoid repeating the experience of 1937, when the economy fell into a recession before it was able to fully recover from the 1929-33 plunge, policy must become stimulative quickly. Since the pols are fixated on deficit reduction, thereby rendering fiscal policy useless, the burden must fall on monetary policy.
I am aware that the Fed has already pumped prodigious gobs of liquidity into the system. I am also cognizant of the possibility that at some point this could lead to a new round of inflation — if it has not occurred already. However, Washington's number-one priority today ought to be jump-starting the economy in order to create jobs.
If the Fed were to engage in a new round of bond buying — call it QE3 — it could push long rates lower as it did under QE2 and provide needed assistance. Besides the immediate past, there is ample precedent for such a gambit.
Back in the early 1950s, the Fed engaged in a program called Operation Twist. Its objective then was to push short-term interest rates higher in order to boost the dollar in world financial markets. At the same time it pushed long rates down in order to encourage business to borrow and invest in capital goods.
Today's version is somewhat different. Short-term rates have remained low to help the fledgling recovery and this time to actually weaken the dollar. But long rates were pulled down as the Fed's purchases reduced the supply of long Treasurys, thereby pushing their prices up and their yields down.
This helped ease financial conditions, boosting stock prices, but little else. The beleaguered housing market did not benefit much because this sector is overbuilt and already loaded with lots of debt. The banks are not lending, preferring instead to buy Treasurys and park their excess cash with the Fed.
A flatter yield curve that would result from another round of bond-buying, along with some cajoling by their regulators, might get the banks off the dime. And more lending should eventually lead to more jobs and a stronger economy.
Thus all that stands between us and another recession is monetary policy. The Fed should twist again, like it did last summer.
Irwin Kellner is MarketWatch's chief economist.
Tuesday, July 26, 2011
Commentary: Monetary policy's all that stands between us and recession
Before you think I have lost my mind, please examine the three facts listed below.
First and most important, the economy — supposedly out of recession for two years — is not in good shape. After rising at a paltry rate of 1.9% in the first quarter, the gross domestic product likely crept ahead at an even slower pace in the second, according to the MarketWatch consensus. This is why the unemployment rate now stands at 9.2% — the highest since the end of last year.
The next fact worth noting is that any agreement to increase the debt ceiling will involve a tightening of fiscal policy. Indeed, such policy has already tightened, since spending by Washington has fallen substantially — enough to cost tens of thousands of federal employees their jobs.
Finally, long-term interest rates have backed up. After dropping to a 52-week low of 2.82%, the yield on the Treasury's ten-year note (^TNX - News) has once again reached 3%. While its yield has been much higher, it has also been much lower and in this economy, lower is better.
If we are to avoid repeating the experience of 1937, when the economy fell into a recession before it was able to fully recover from the 1929-33 plunge, policy must become stimulative quickly. Since the pols are fixated on deficit reduction, thereby rendering fiscal policy useless, the burden must fall on monetary policy.
I am aware that the Fed has already pumped prodigious gobs of liquidity into the system. I am also cognizant of the possibility that at some point this could lead to a new round of inflation — if it has not occurred already. However, Washington's number-one priority today ought to be jump-starting the economy in order to create jobs.
If the Fed were to engage in a new round of bond buying — call it QE3 — it could push long rates lower as it did under QE2 and provide needed assistance. Besides the immediate past, there is ample precedent for such a gambit.
Back in the early 1950s, the Fed engaged in a program called Operation Twist. Its objective then was to push short-term interest rates higher in order to boost the dollar in world financial markets. At the same time it pushed long rates down in order to encourage business to borrow and invest in capital goods.
Today's version is somewhat different. Short-term rates have remained low to help the fledgling recovery and this time to actually weaken the dollar. But long rates were pulled down as the Fed's purchases reduced the supply of long Treasurys, thereby pushing their prices up and their yields down.
This helped ease financial conditions, boosting stock prices, but little else. The beleaguered housing market did not benefit much because this sector is overbuilt and already loaded with lots of debt. The banks are not lending, preferring instead to buy Treasurys and park their excess cash with the Fed.
A flatter yield curve that would result from another round of bond-buying, along with some cajoling by their regulators, might get the banks off the dime. And more lending should eventually lead to more jobs and a stronger economy.
Thus all that stands between us and another recession is monetary policy. The Fed should twist again, like it did last summer.
Irwin Kellner is MarketWatch's chief economist.
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