The Federal Reserve announced a month ago its plan to buy an additional $600 billion of Treasury securities in order to stimulate the economy. This second round of “quantitative easing” made some people cringe, for some very different-- even contradictory-- reasons. On the one hand it stirred inflation phobia in those that see excess liquidity as one of the root causes of the financial mess that we were (and still are) in. They argue that QE2 would only encourage another round of reckless financial speculation and bubbles, at a time that we least need it. On the other hand, pessimists about the Fed’s plan see no way that QE2 would accomplish the job that it is intended to, for mainly two reasons. First, the private sector is heavily in debt already and therefore has little capacity to borrow more, consume more, and invest more, not to mention that the financial intermediation sector itself is barely surviving. Lower policy rates are thus difficult to be arbitraged to the private sector’s benefit. Second, with the growth prospect in emerging markets much brighter than in the advanced economies, additional liquidity added to the system here will be quickly moved to, say, the other side of the Pacific, and ends up as emerging markets’ capital inflow and even higher foreign reserves.
While the inflation worry is still far-fetching given the currently depressed level of economic activities in this country, the skepticism about the effectiveness of QE2 seems justified. However, I’m going to argue that quantitative easing is probably more likely to work in the United States than in any other countries in the world, for two reasons. First, although the credit channel may be clogged, the policy-induced asset price increase will likely to encourage consumption through wealth effect. The asset price channel can be especially effective in the US because of the high percentage of stock ownership. Half of the US households own stocks, either through investment in individual stocks or through investment in mutual funds. This means that the wealth effect generated through higher stock prices can be far reaching, directly to half of the population and indirectly to an even wider range.
Secondly, higher asset prices are especially beneficial to the intangible-capital intensive industries and technology sectors, which in the long run drive the growth potential of the US. Partly because of the nature of their assets, intangible-capital intensive firms are more likely to seek finance through equity offering than borrowing from banks, as the latter normally requires tangible collaterals. Thus a depressed stock market is extra restrictive to the growth of high intangible sectors by making equity financing difficult. Moreover, the US has a much higher percentage of enterprises financed by venture capital and private equity firms than any other countries. Active venture investment is an important source of American innovation edge and long-run productivity growth. Venture capital firms typically exit from their investments in portfolio firms through selling their shares to other firms or to the public market. If the asset market is doing well, it’s easier for venture capitalists to exit and then invest in new firms. In contrast, when they can’t sell their existing portfolios, new start-up companies that carry productivity-enhancing potentials will be starving, too. Investing in long-term productivity and innovation is arguably the wisest thing a country can do during a downturn. But unfortunately, the funding constraints for long-run investments are most severe in the recession. People often neglect long-term goals when faced with immediate urgencies. To put things in perspective, the projected total investments in US new enterprises for 2011 is around $20bn (that’s already a significant increase from this year); in contrast, the auto bailout in the US cost $80bn, and that was only estimated in 2009.
Again, whether QE2 will be all that effective in stimulating the economy in the short run is debatable. But at least we know that if it is going to be of help, it will be most helpful here in the States. And even if it doesn’t have immediate effect on the economy, it will still have long-term benefit, though a lot of it may not be directly measurable.
2 comments:
"First, although the credit channel may be clogged, the policy-induced asset price increase will likely to encourage consumption through wealth effect. The asset price channel can be especially effective in the US because of the high percentage of stock ownership. Half of the US households own stocks, either through investment in individual stocks or through investment in mutual funds."
The issue with the US is that businesses are not responding to lower interest rates (which are close to zero). I'd go even further and argue that the wealthier portion (the ones more likely to own stocks) of the population are saving and have no reason to spend. Hence I think evidence points that the wealth effect is not really happening.
There is another reason why Quantitative Easing has been under criticism. And lends to the debate of fiscal spending vs QE. Fiscal spending, if done right, can target poorer segments of the population who are more likely to spend. QE on the other hand may relatively target the wealthier segment, where its ambiguous if they are likely to spend.
Both QE and fiscal spending have negative ramifications of course.
just read 2day article. thank you so much 4 share your brains with us. happy to read yr stuff.
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