QE3 and Our Long-Term Economic Outlook

Mercatus Center Scholar Steve Horwitz answers questions on the latest round of quantitative easing (QE) and what it means for our long-term economic outlook.

1. Should the Federal Reserve have launched QE3?

No.  Aside from the fact that QE extends the Fed’s powers beyond what central banks have typically done in the past, thinking that we need more monetary easing misdiagnoses the problem.  The Fed appears to be buying into the argument that our slow recovery is the result of a lack of aggregate demand.  An alternative view would put the blame on the deep structural distortions that were generated during the housing boom.  Those malinvestments take time to unwind and it takes more time for entrepreneurs to reallocate those resources to new, better uses.  That readjustment process has been slowed by various misguided policies that have subsidized and thereby locked in the mistakes of that boom.  Every time we try to prop up housing prices or bail out failed industries, we slow recovery.  Add to that the uncertainties about the election and policy more generally, and private investors are understandably reluctant to commit resources to the private sector.

The danger of QE, of course, is inflation down the road.

2. Chairman Bernanke went with an open-ended easing this time—was that the right move? 

Whenever a central bank policy is open-ended or uncertain, it makes folks nervous.  Markets in some sectors may like that move because they will benefit from the added liquidity.  However, the ability to engage in more QE at any time down the road can also be a source of further uncertainty.

3. How does the lesser-noted decision to keep interest rates at or near 0% even after the economy starts to show signs of real recovery sit with you?

Keeping rates that low is deeply concerning, as it was artificially low rates that were one of the key factors in generating the housing boom that led to the bust and current slow recovery.  The danger of those super-low rates is that they will induce another round of malinvestments by falsely encouraging longer-run projects that will ultimately be unsustainable, as was so much of the investment in housing last decade.   

4. We haven’t seen much inflation yet—at least partly due banks sitting on increasing amounts of capital reserves—are you worried that this will change given QE3 and/or increased lending from banks if the economy shows signs of strengthening again?

Many of us have been worried about this for a while and it has yet to materialize.  QE3 doesn’t necessarily make it more likely that the expansion of the monetary base will turn into growth in the money supply and spending, but it does mean that if and when it does, the risk of damaging inflation will be that much higher.  It also means that the process of unwinding the injection of all those reserves becomes that much more difficult.