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QE3: motives and limits to the move
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The Federal Reserve Bank's recent move, dubbed "QE3," has caused both confusion and controversy among pundits and the general public.

For those who don't religiously follow this stuff, "QE" stands for "quantitative easing." The "3" stands for the third round of the Federal Reserve Bank System's attempt to do its part to produce a full employment economy.

I don't know who comes up with obtuse terms like "QE3," but it is an unnecessarily obscure term for what students of economics learn as an "expansionary monetary policy." In clear English, it simply means making credit more available at lower interest rates.

The nation's Federal Reserve Banking System has a number of responsibilities, including regulating federally chartered banks. Its chief policy function is conducting the nation's monetary policy through influencing the nation's money supply and interest rates. (Note the word "influence," as opposed to "control.")

As the nation's population and economy expands, so too must the money supply to enable an expanding economy. That is, for businesses to start up, expand, and grow, the need for money and credit expands. For business and the economy to prosper, money and credit must be made available, but not to the extent that it will bring on inflation.

Monetary policy is one of the major policy tools used for macroeconomic stabilization. The objective of monetary policy conducted by the Federal Reserve System, commonly called "The Fed," is to promote the objective of full employment and stable prices. The policies by which to carry out these objectives are implemented by the Fed's Board of Governors, headed formerly by Alan Greenspan, and currently, by Ben Bernanke.

A second major set of policy tools by which to influence the economy is fiscal policy, the system of federal taxes and expenditures that influence the nation's aggregate demand. Fiscal policy is set by the Congress and the president of the United States.

Because fiscal policy and monetary policy are set by different entities, i.e., fiscal policy by the president and the Congress, and monetary policy by the Fed, there may be, and often are, conflicts - between the president and the Congress, between the R's and D's within the Congress and, therefore, more broadly, between fiscal and monetary policy.

So here is the present scenario: An economic recession is technically defined as two successive quarters of declining economic activity as measured by Gross Domestic Product (the gross market value of all goods and services produced in the nation in one year). The recent "Great Recession," the most severe since the Great Depression of the 1930s, spanned the period from December 2007 to June 2009.

Although now technically out of recession, the economy has grown at a slow pace, with unemployment, all will agree, at a rate too high, hovering around 8 percent. Economists generally agree that an unemployment rate of around 4 percent is a practical target as there will always be some "frictional" unemployment even in an expanding economy. Complicating further the current 8 percent unemployment rate is that some of the current employment is at lower wage rates, as the nation has lost some high wage manufacturing jobs to foreign producers.

The standard economic policy prescription during recession calls for some combination of reduced taxes, and an increase in federal spending to compensate for decline in consumer spending and private investment. The combination of reduced tax revenue (resulting both from reduced incomes during recession, and possible legislated tax cuts), and increased federal spending (resulting from automatic payments for unemployment compensation, and possible deliberate stimulus expenditures) will necessarily result in a federal deficit.

Mainstream economists, and some, though not all, lawmakers see a federal deficit preferable to increased unemployment, which would, arguably, result in even greater federal deficits because of reduced tax revenue - this in addition to domestic hardship and unrest.

So, where does QE3 enter the mix? We have had two rounds of easing of credit and lower interest rates. Why the third?

The proponents of QE3 admit that its effect will be marginal, at best. But given gridlock in Congress (recall sthat it, along with the president, controls fiscal policy), it's the only tool, however inadequate, available at this time. The existing federal deficit has the Congress spooked and, in any case, deadlocked. Even worse, barring action, we are heading for a so-called "fiscal cliff." The "fiscal cliff" refers to the automatic tax increases and spending cuts that will occur if the Congress does not act before December 3, 2012. Failure to act on this is virtually certain to bring on renewed recession.

While mainstream economists see QE3 as the correct move, let us not be too optimistic as to its effect. The tools of monetary policy are asymmetric in their effectiveness. A contractionary or tight monetary policy with high interest rates and stringent credit requirements is sure to dampen economic activity.

In contrast, an expansionary, or easy monetary policy, with low interest rates and easier credit terms enables borrowing, investing, and spending, but does not ensure it. It's like pushing string - you can provide the slack, but there has to a source to pull it. In economic terms, credit can be made available, but someone has to be able and willing to borrow and spend the dough.

Therefore, while QE3 is a rational and correct policy move, let us not be too optimistic as to its overall effect. An improved economy depends on other things as well, including a foreign trade policy that is more favorable to American workers, and an expansionary fiscal policy with a better mix of federal expenditures and tax cuts that favor the middle class.

Next week: The advantages and limitations of fiscal policy.

- John Waelti's column appears every Friday in the Times. He can be reached at He is a retired professor of economics.