“There are studies that indicate that economic growth slows when public and private debt exceeds 260% to 275% of GDP. The U.S. hit the 260% level in 2000.”
A recent paper by Hoisington Investment Management Company (available here) does an excellent job describing why the Federal Reserve is, and will continue to be, unsuccessful in its efforts to engineer economic growth by devaluing the U.S currency and attempting to increase inflation through persistent “Quantitative Easing”. They cite four factors:
1) The Fed’s Forecast: If the Fed’s forecasts were consistently right, we could have confidence that their actions might positively impact the economy. However, their forecasts for GDP and inflation have been “consistently above the actual outcomes”. They assume higher stock prices will lead to more spending because people feel wealthier if their portfolio is rising. This “wealth effect” has not occurred, nor is there evidence that this correlation always exists.
I would add to this argument that continued uncertainty about the future financial health of individuals and the country eliminates any wealth effect in the short-run.
2) Excessive Debt: There are studies that indicate economic growth slows when public and private debt exceeds 260% to 275% of GDP. The U.S. hit the 260% level in 2000. This has caused real median household income to decline and with it the standard of living.
I suggest this has led to “debt saturation”, a point at which each dollar of debt added produces NEGATIVE productivity and actually reduces GDP per dollar invested in the economy (see blog post here). No company or government can survive with negative returns on their “investments”.
3) Scholarly Evidence that Large Scale Asset Purchases (LSAP) Don’t Work: We have been using LSAP as a Fed strategy with no evidence of proportionate economic improvement. While the Fed’s balance sheet has increased fourfold, there has been no measurable benefit to the economy.
I would add that this policy is also contributing to the fear and uncertainty that is stagnating the economy. No one knows what will happen when the Fed unwinds an LSAP of this scale, so even those who have seen their “wealth” increase during the past 5 years fear it is not real or permanent wealth. Also, the policies have not benefited the vast majority of working Americans; only the “elite” investment class. There remain few incentives to create jobs through U.S. based business expansion due to high corporate income taxes and a crippling regulatory environment.
It is also interesting to note that John Maynard Keynes, the father of Keynesian economic stimulus, would not recommend the current LSAP policy. Keynes was an economic nationalist who was opposed to globalization in large part because he believed stimulus policies would not be effective in a global economy. He warns of “capital leakage” when countries in a global economy attempt stimulus. He would counsel that money injected into the U.S. economy is likely to be spent on the expansion of offshore operations and not likely to create jobs for those in the U.S. See his position on stimulus in a global economy here.
4) Money Velocity: The fourth problem is that the Fed cannot control the velocity of money. The authors state: “Nominal GDP is equal to the velocity of money (V) multiplied by the stock of money (M), thus GDP = M x V” (p. 3). The velocity of money reached its peak in 1997 as the private and public debt reached the nonproductive zone, discussed in bullet #2, and has been falling ever since. It is currently the lowest it has been in 60 years. The accumulation of high levels of debt has rendered monetary policy ineffective.
The paper goes on to describe the unintended consequences associated with Fed monetary policy, but you’re probably already living them.
Dr. Holly A. Bell is an Associate Professor teaching business and economics at the Mat-Su College of the University of Alaska Anchorage in Palmer, Alaska. You can visit her website at www.professorhollybell.com or follow her on Twitter at @HollyBell8