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Ill at Ease: AFP Members, Some Fed Officials Think QE2 Could Backfire

  • By Kevin Roth, Ph., Managing Director, Research and Strategic Analysis, AFP
  • Published: 2011-01-03

This story was excerpted from the December 2010 issue of Exchange magazine.

The first days of November were quite eventful. The next day, the Federal Open Market Committee voted to purchase an additional $600 billion in Treasury securities over an eight month period through June 2011 to pump additional liquidity into the U.S. economy. First, American voters cast their votes for the mid-term elections that resulted in a change in control in the House of Representatives and a narrower majority for the Democrats in the Senate.

Less than a week later, AFP asked attendees at its Annual Conference in San Antonio what impact either would have on business conditions in the coming months. Overall, financial professionals said they were more likely to expect a positive impact on U.S. business conditions resulting from the midterm elections than they were from the Federal Reserve's decision to resume its policy of quantitative easing.

Fifty-four percent of conference attendees believe that the election results will have a beneficial impact on general business conditions, with 51 percent believing the results will have a beneficial impact specifically on their own organizations. Only 8 percent of survey respondents expect the election results will hurt their organizations' prospects over the next year, with 12 percent anticipating a negative impact on overall business conditions.

By comparison, 51 percent of financial professionals expect the Fed's second round of quantitative easing would be beneficial to U.S. business conditions. Yet, only 42 percent see the move as enhancing their organizations' business prospects.

One reason why survey respondents are less enthusiastic about the second round of securities purchases by the Fed is that many financial professionals do not believe the action addresses what they view to be the main problem for the U.S. economy. Simply, many companies continue to sit on massive sums of cash, as pointed out in the Federal Reserve's Flow of Funds data and in the 2010 AFP Liquidity Survey.

In addition, access to credit appears to be a diminishing concern for organizations. Ninety-six percent of survey respondents report that credit access has either improved or remained the same over the past 12 months. Only 16 percent of survey respondents identify access to credit as a factor that is keeping their organization from investing for the future (e.g., making capital investments, hiring additional workers). Further, credit does not appear to be concern going forward either—only two percent of survey respondents anticipate deterioration in their organizations' access to credit in the coming year.

Instead, financial professionals point to other factors to explain why their companies have been slow to increase capital investments and hiring. The most widely cited factor is the continued weakness in consumer demand and spending (40 percent of survey participants). Others barriers to growth include issues dealing with uncertainty:

  • Adversity to risk given current environment (39 percent)
  • Uncertainty/extent of business regulations (33 percent)
  • Perceived/real anti-business sentiment in Washington (22 percent)
  • Uncertainty about future tax policy (20 percent)

In the time since the November FOMC meeting, there has been considerable debate over the Committee's decision to purchase $600 billion in Treasury securities and to reinvest principal payments made on previous securities purchased by the Federal Reserve. Advocates of the resumption of quantitative easing point out that it is necessary to promote economic growth and hiring. They also express anxiety that the U.S. will fall into a deflationary cycle. Others, however, have expressed concern about the action's impact on inflation and the value of the U.S. dollar.

The pro-QE2 side naturally includes Federal Reserve Chairman Ben Bernanke, who defended the policy as not being particularly "unconventional," adding that the Fed was "not in the business of trying to create inflation." In a commentary piece he wrote for the Washington Post, Bernanke stressed that "the Federal Reserve has a particular obligation to help promote increased employment and sustain price stability." He feels strongly that the resumption of quantitative easing is a critical part of the Fed in fulfilling this mandate. A number of other voting members of the FOMC have since spoken publicly to support the move.

But the decision was not unanimous. Federal Reserve Bank of Kansas City president Thomas Hoening has been on the losing side of FOMC decisions for much of 2010, including the decision of the FOMC to continue signaling its intention to keep the Fed funds target rate at near zero for "an extended period." In November, he voted against the resumption of quantitative easing because he "believed the risks of additional securities purchases outweighed the benefits." He also is "concerned that this continued high level of monetary accommodation increased the risks of future financial imbalances and, over time, would cause an increase in long-term inflation expectations that could destabilize the economy."

But even some who voted with the majority did not believe that continued accommodative policy was advisable.

In a speech delivered to attendees of the Executive Institute at the AFP Annual Conference, Federal Reserve Bank of Dallas President Richard Fisher opined that the FOMC was "taking a calculated risk" that could result in "super inflation" should Congress and the White House "fail to deliver." Specifically, he was looking for a "sensible budgetary and regulatory path that incentivizes businesses" to expand payrolls without causing a "looming fiscal apocalypse." Rather than promoting job creation, Fisher fears that the latest wave of quantitative easing would lead to "a declining dollar, encourage further speculation, provoke commodity hoarding, accelerate the transfer of wealth from the deliberate saver and the unfortunate, and possibly place at risk the stature and independence of the Fed."

So, the balancing act between stimulating economic growth with job creation and keeping inflation continues. Thus far, inflation remains non-existent at the consumer level. Core consumer prices—which remove the typically volatile energy and food sectors from the analysis—were up only 0.6 percent over the 12 months up to October. In the view of many, not only does the lack of inflation give the Fed plenty of room to continue propping up the economy, it actually makes it the Central Bank's prerogative to do so to stave off deflation.

However, the other side points out that hyperinflation does not necessarily build slow, but could happen all the sudden, making current data showing little inflation moot. Further, producer prices—especially early in the production cycle—have been percolating for some time. It is weak demand that has prevented these cost increases to be passed onto consumers thus far. But how long will that last, they ask?

The answer to that question is one of several that will determine the eventual success of the second round of quantitative easing. 2011 will be no less interesting than 2010 has been.

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All rights reserved.

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