Tags: Makin | QE | Fed | rates

AEI's Makin: Here Comes QE4!

By    |   Thursday, 05 September 2013 08:57 AM

John Makin, resident scholar at the American Enterprise Institute, is a major skeptic about whether the Federal Reserve is about to start tapering back on its $85 billion monthly Treasury bond purchases, also known as quantitative easing (QE), as many economists expect.

Instead, Makin believes the central bank is headed in the opposite direction.

"It is more likely, in view of the negative impact on the already weak U.S. economy arising from the higher interest rates resulting from taper talk, that the Fed will have to reverse itself (again) and start talking about 'un-tapering' or QE4 at its December meeting," he wrote in a column for Real Clear Markets.

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Since the Fed Chair Ben Bernanke hinted at cutting back on ultra-loose monetary policy in May, higher mortgage rates have spooked homebuilders and homebuyers. June housing starts sank over 9 percent from May.

Makin said there are three reasons to expect a reversal of both higher interest rates and taper talk. First, because the federal budget deficit is dropping, the government doesn't need to borrow as much.

"If, for example, the Fed cuts QE bond purchases by $20 billion per month in September, as some have suggested, there is an actual reduction in the supply of bonds for markets to absorb in the 2014 fiscal year that begins on Oct. 1, 2013," he explained.

"Given the sharp drop in deficits, the Fed can cut bond purchases by about $40 billion per month — $480 billion per year — and leave the net supply unaffected based on post-2012 deficit reduction."

Meanwhile, a slowing of the U.S. economy may also force the central bank to take tapering off the table, he argued. Consensus forecasts of third quarter GDP growth have already been slashed from 2.5 percent in August to 1.5 percent now.

"The slowdown is a natural result of early 2013 tax increases and from spending cuts tied to the sequester that imparted a 2013 'fiscal drag' equal to about 2 percentage points of GDP growth," Makin wrote.

A third reason for interest rates to decrease, and possibly QE to actually to be increased by the Fed — not tapered — is a persistent drop in inflation. The Fed has aimed at lowering unemployment to about 5.5 percent along with an inflation rate of about 2 percent, but neither goal has been attained.

"Actual inflation is currently closer to 1 percent, and by that criteria, as well as the 'full employment' criterion, the Fed should be increasing its underlying QE, not tapering it," Makin stated.

"Taper talk will end soon, displaced by talk of QE4. We've had two false starts toward Fed tightening since 2009. Now taper talk has given us a third."

However, the conventional wisdom among economists is that current favorable economic data has "firmed bets" that the Fed will start tapering at its policy meeting on Sept. 17 and 18, unless U.S. jobs numbers on Friday are lower than forecasted, Reuters reported.

"The Fed is likely to taper this month and that is going to keep the dollar underpinned," Paul Bednarczyk, head of research at 4Cast, told Reuters. "Tapering is going to be the first step towards policy tightening before other major central banks so people will start buying dollars."

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John Makin, resident scholar at the American Enterprise Institute, is a major skeptic about whether the Federal Reserve is about to start tapering back on its $85 billion monthly Treasury bond purchases, also known as quantitative easing (QE), as many economists expect.
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2013-57-05
Thursday, 05 September 2013 08:57 AM
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