The Federal Reserve’s announcement of a third round of quantitative easing (QE3) might have been the worst kept secret, yet the dollar plunged upon the a nnouncement. Here we share our analysis on what makes the FOMC tick, to allow investors to position themselves for what may be ahead.
We have heard policy makers justify bailouts and monetary activism because, as we are told, these are no ordinary times: extraordinary times require extraordinary measures. Acronyms are needed, as we are told that things are complicated. We respectfully disagree. It’s quite simple: we have had a credit driven boom; we have had a credit bust; and Fed Chairman Bernanke thinks monetary policy can fix it. Merk Senior Economic Adviser and former St. Louis Fed President William Poole points us to the fact that the Soviet Union, Cuba and North Korea have one thing in common: monetary policy could not have compensated for the shortcomings of the respective regimes. The successor nations to the Soviet Union, as well as China had economic booms because they opened up, not because of printing presses being deployed. Monetary policy affects nominal price levels, not structural deficiencies. In the US, the economy may be held back because of uncertainty over future taxes (the “fiscal cliff”) and regulation; monetary policy cannot fix these.
But the above experiences have something else in common: they refer to lessons of recent decades. Bernanke, in contrast, is a student of the Great Depression, the 1930s. Bernanke firmly believes that tightening monetary policy too early during the Great Depression was a grave mistake, prolonging the Depression. Never mind that there had been major policy blunders by the Roosevelt administration that might have been driving factors; Bernanke’s research squarely focuses on how history would have evolved differently had his prescription for monetary policy been implemented.