It is widely believed that TARP and the Fed, through purchases of nearly $2.5 trillion of non-performing loans, mortgages, Treasury bonds and other assets (collectively termed Quantitative Easing [QE]) prevented economic collapse and lowered the cost of debt financing by lowering interest rates. Fed Chairman Bernanke explicitly stated that the objectives of QE are a wealth effect on consumption from higher asset prices and lower interest rates intended to spur investment and indirectly increase employment. At the same time, the Fed remains committed to managing to an approximate 2% inflation target while expanding the Fed's asset purchase program at a rate of $40-$85 billion per month until the unemployment rate reaches a satisfactory level.
This article shows that the actual effect on the economy slows real wage and employment growth, thus restraining GDP growth and negates a wealth effect through the following mechanism:
- GDP is a return on the economy's total asset base.
- Wherein capital and other asset formation normally occurs in proportion to GDP growth and where growth is the required return on capital formation.
- The long run return on capital and labor is equivalent.
- QE has created an abnormal (excess) supply of new capital which necessarily lowers its available real return from GDP growth. This requires that real wage growth also stagnate because low capital returns cannot accommodate real wage growth. Stagnating real wage growth, normally equal to productivity growth, depresses real GDP growth.
- Worse, the 2008-09 recession should have resulted in deflation as both the non-performing assets and the associated false real wage growth were wrung out of the economy. Fiscal and monetary policy prevented price and wage deflation, leaving a wage level that cannot accommodate full employment. The consequences are impaired GDP growth and high structural unemployment and fiscal deficits.
- QE has caused low real yields on bonds, thus reducing expenditures from interest income, and causes an under-valuation of the stock market by forcing returns normally expected to come from earnings growth to derive from dividend yield: see my Seeking Alpha articlehere. This is an anti-wealth effect, and the opposite of the Fed's stated goals.
- The negative real yields may impair, not spur investment if investment is made in expectation of a required real return rather than merely low real cost of capital.
- Finally, the Fed cannot simply "exit" QE because selling bonds to mop up the liquidity it created still leaves the excess capital in the form of new bonds on which the government must pay interest and principal through further money creation.
QE is a purely nominal attempt to solve a real economy problem.
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