The Federal Reserve’s decision to roll out a third round of bond buying will do little to boost stock prices and stimulate the economy, said New York University economist Nouriel Roubini.
The Fed recently announced plans to buy $40 billion in mortgage-backed securities held by banks every month until the economy and labor market improve, a monetary policy tool known as quantitative easing (QE).
The announcement marks the third time the Fed has rolled out quantitative easing measures to jolt the economy since the 2008 financial crisis, with the first round (QE1) seeing the Fed snap up $1.7 trillion in mortgage securities and the second round (QE2) seeing the Fed buy $600 billion in Treasury securities held by banks.
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QE aims to stimulate the economy by injecting the financial system full of liquidity via bond purchases that push down interest rates to encourage investing, job demand and stock market gains.
This time around, however, QE will do little for stock prices and the economy, as equity indices are already high due to past stimulus measures, and further liquidity injections won’t send them much higher, Roubini said.
Furthermore, QE1 and QE2 came alongside fiscal stimulus polices rolled out by the White House, which gave the economy a jolt.
“In March 2009, the S&P 500 index was down to 660, earnings per share (EPS) of U.S. companies and banks had sunk to a financial-crisis low and price/earnings ratios were in the single digits,” he wrote in a Project Syndicate column.
“Today, the S&P 500 is more than 100 percent higher (hovering near 1,430), the average EPS is close to $100 and P/E ratios are above 14.”
Meanwhile instead of fiscal stimulus, the country is facing a fiscal cliff.
At the end of this year, tax cuts are scheduled to expire at the same time pre-programmed cuts to government spending kick in, a combination known as a fiscal cliff that could send the country sliding into a recession next year if left unchecked by Congress.
Even if Congress does steer the country away from the cliff, a compromise could involve adjustments to taxes and government spending that could dampen growth next year.
“In short, QE3 reduces the tail risk of an outright economic contraction, but is unlikely to lead to a sustained recovery in an economy that is still enduring a painful deleveraging process,” Roubini wrote.
“In the short run, QE3 will lead investors to take on risk and will stimulate modest asset reflation. But the equity-price rise is likely to fizzle out over time if economic growth disappoints, as is likely, and drags down expectations about corporate revenues and profitability.”
Still, Fed officials remain firm in their commitment to pump liquidity into the economy, as unemployment rates remains unacceptably high while inflation rates remain in check.
“It appears that the economy is growing at a pace such that, absent policy action, progress on reducing unemployment will likely be slow for some time,” Fed Governor Jeremy Stein said at an event at the Brookings Institution, according to Reuters.
“Given where we are, and what we know, I firmly believe that this decision was the right one.”
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