In the tranquil surroundings of Jackson Hole, Wyoming, a peculiar gathering of financial experts holds some curious beliefs. They assume they can set the price of the economy’s most crucial element—money—better than the market itself. This belief leads them to undervalue the cost of money in hopes of encouraging consumers to spend beyond their means on unnecessary goods and services.
At first glance, this may seem irrational. However, it reflects the prevailing aim of today’s monetary policy. Yet, the situation is even more complex…
When commercial banks decide not to distribute the plentiful cheap credit through personal and business loans, the central banks’ plans to stimulate the economy falter. This leads to an increased reliance on fiscal policy to fill the gap. Government economists pursue the idea that substantial spending—often financed through borrowed money—can effectively boost the economy, despite the obvious contradiction of spending funds that the government does not possess.
To finance this spending, the government borrows from the central bank. Yet, the central bank doesn’t possess additional funds either; it simply generates money through bookkeeping entries and records this as an asset.
It’s perplexing how this practice continues, but it has persisted far longer than anyone with a grounded understanding would expect…
Testing Precarious Monetary Policies
In the 1980s and 1990s, the economy appeared relatively stable, leading many academics to believe that monetary issues had been effectively resolved. However, in retrospect, it is evident that financial concerns were merely masked by escalating debt—a burden that the economy can no longer sustain.
Federal Reserve Chairman Ben Bernanke devoted his career to studying the Great Depression. For years, he crafted theories focused on countering debt deflation and declining aggregate demand. His most significant contribution prior to chairing the Fed was developing the theoretical groundwork for quantitative easing. He likely never anticipated that he would have to apply such controversial strategies.
However, when credit markets faltered in 2008, Bernanke found himself at a crossroads, compelled to rigorously test his ambitious monetary policies. Trillions were added to the Federal Reserve’s balance sheet, alongside a staggering $7 trillion increase in public debt. Despite these extensive measures and the expectations for a rebound in economic prosperity, a genuine recovery eluded us.
What went wrong?
The mechanism intended to transmit the Fed’s cheap credit—commercial banks—failed to circulate this influx of money into the economy. Additionally, contrary to economist Paul Krugman’s predictions, the government spending facilitated by the Fed also proved ineffective.
This certainly wasn’t how Bernanke envisioned outcomes unfolding. Moreover, his strategies have inadvertently set the stage for even greater economic challenges…
The Clever Fellows of Jackson Hole
Eventually, banks will begin lending a greater portion of the reserves created by the Fed. Once this flow of money accelerates, inflation is likely to escalate rapidly. The potential for rampant inflation arises from all the dormant capital accumulated since 2008, which can suddenly surge into the economy.
Moreover, quantitative easing has inflated the stock market to unprecedented levels. Wall Street has grown to anticipate such measures, leading to a summer rally in stock prices based on expectations for QE3.
As we reach the final day of August, all eyes are turned toward Bernanke. This afternoon, he will emerge from his retreat in Jackson Hole to share his thoughts, potentially offering fresh insights into the future of quantitative easing.
Is more quantitative easing the solution to the economic malaise? If so, how extensive should it be? Should it be open-ended or bound by limits? And how will inflation be managed when the flood of excess money enters the economy?
What will additional QE mean for stock markets? Could it incite a substantial bubble? And regarding Treasuries? How long can interest rates remain suppressed before they surge? What unforeseen consequences may arise?
Without a doubt, Bernanke and his colleagues—the clever minds of Jackson Hole—are fully aware of the implications of their actions. They always are. One can only hope that their awareness leads to a better outcome…
Sincerely,
MN Gordon
for Economic Prism
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