Economists at Goldman Sachs estimate the Federal Reserve may need to buy a staggering $4 trillion worth of assets such as Treasury securities to get the economy rolling again.
The Goldman economists, Jan Hatzius and Sven Jari Stehn, don’t expect the Federal Reserve to go nearly that far when it resumes its asset-purchasing quantitative easing policy. Citing many officials’ unease with the prospect of adding significantly to the Fed’s already bloated balance sheet, Goldman expects the Fed to end up buying around $2 trillion worth of assets over the next few years.
But even the lower Goldman estimate at least doubles the size of the purchases most observers have been saying they expect the Fed to target when it unveils so-called QE2 at its meeting next week.
“The key strategic question is not the size of the first step, but how far Fed officials will ultimately need to move in order to achieve their dual mandate of low inflation and maximum sustainable employment,” Hatzius and Stehn write.
Hatzius and Stehn say that with unemployment near 10% and inflation falling, there is no reason to believe the widely anticipated, modest second round of quantitative easing will pull the economy out of its funk. Economists have been bandying about figures between $500 billion and $1 trillion, though some suspect the Fed will stop short of using numbers even that large and simply announce a plan to buy $80 billion to $100 billion worth of Treasurys till conditions improve.
The Fed has been complaining in recent weeks that inflation is falling too low, in a development that threatens to raise real borrowing costs for households and businesses, further slowing an already anemic recovery. Meanwhile, Fed chief Ben Bernanke said in a speech this month that joblessness “is clearly too high relative to estimates of its sustainable rate.”
Those comments point to a building consensus at the Fed for another round of monetary stimulus in a bid to boost demand for goods and services. At the same time, commodity prices have surged over the past three months and interest rates have plunged, leading some observers to question whether the market has already priced in next week’s announcement — and raising fears that an all-in approach such as the one described in Goldman’s $4 trillion scenario could lead to a destabilizing surge in goods prices.
But for now, the burning question is why all the stimulus the Fed has provided over the past few years has eased financial conditions without aiding the actual economy. The Goldman economists answer that while the Fed’s current policy is “very easy,” that’s not nearly loose enough.
“Instead, policy should be massively easy to facilitate growth and job creation, fill in the output gap, and ultimately raise inflation to a mandate-consistent level,” they say.
The Goldman economists acknowledge the risks the Fed faces in doing new asset purchases, such as rising friction with critics in Congress and fears that the massively expanded monetary base will make it impossible to avoid a large dose of inflation down the road.
But skeptics of the Fed’s firepower, and by now there are many, say the bigger problem is that the benefits of QE will simply be siphoned off by unfair traders such as China. They say the answer to our economic morass thus must come from the White House and Congress rather than from the Federal Reserve.
“China’s yuan policy and trade barriers make the Fed nearly irrelevant,” writes University of Maryland business professor Peter Morici.