22nd October 2010
Expectations of a fresh stimulus situation have gained considerable traction since the US Federal Open Market Committee (FOMC) minutes for its September 21 meeting were released on October 12. They contained hints of another round of quantitative easing (QE), with the committee considering various options to deliver additional stimulus and potential steps to affect inflation expectations going forward.
Azad Zangana, economist at Schroders, is sceptical another round of QE in the US will have much impact even though he believes the first round across the pond in 2009 was arguably more effective than the one carried out in the UK.
In its first round, for instance, the Fed directly purchased troubled Mortgage Backed Securities (to the tune of a staggering $1.25 trillion). That in turn helped banks balance sheets, and even stimulated some lending.
In addition, Zangana points out, the Fed also bought US Treasuries, which brought down borrowing costs for the government and many corporations.
In all, the Fed's monetary easing programme in 2009 resulted in it running up a balance sheet of about $2 trillion worth of securities.
So in broad terms the first US QE programme was deemed to have a meaningful impact on long term interest rates, including for mortgages, auto loans and unsecured bank credit, as these rates gradually fell over the course of the year, making credit more available on better terms to households and businesses.
But Zangana does not believe another round of QE will be as effective this time in the US (or the UK) as yields on government debt are already low. "Banks want to consolidate, and households do not want to take on more debt at the moment," he says.
There is considerable uncertainty about the structure of QE2 in the US but Goldman Sachs economists, according to FT.com, reckon its most likely form will be monthly purchases of $80bn-$100bn for about six months.
Elsewhere, Morgan Stanley analysts cited in an International Business Times report, believe US easing will help exports. They argue fast growing emerging markets countries will be flooded with dollars and they will eventually buy more U.S. goods as a result.
Additionally, they argue, economies with low inflation and moderate economic growth will probably want to keep their currencies low to boost exports. "So as dollars flow into their financial system, their central banks will accumulate them and issue domestic currency. This will boost domestic liquidity, which will lead to economic expansion, higher incomes, and consequently greater demand for goods, including those from the U.S.," they say.
As for the FOMC comments on inflation, the minutes reveal that committee members considered three options for affecting inflation expectations. The first involves adopting a more explicit constant rate of inflation. Currently the target is assumed to be close to 2%, but analysts at Henderson Global Investors believe the FOMC may look to make this a more explicit aim over a given time horizon.
The second and third options are more radical and involve targeting a path for price or nominal gross domestic product (GDP). Targeting a price level, rather than an inflation rate, would involve keeping track of deviations of inflation from its desired rate – for example, an inflation undershoot by 1% in one year will have to be offset by pushing it above target in future years. Henderson analysts say this would likely result in more stable inflation expectations, but also a more volatile economic environment.
The third option, to target a level for nominal GDP, has obvious drawbacks since GDP data are not as readily available as prices and are often revised at a later date.
The analysts conclude: "Whilst each of these approaches have their advantages and disadvantages, their aim would be to encourage better formed expectations for growth and inflation, which is increasingly important for investors as interest rates lean towards zero. We do not foresee these being adopted any time soon, although it is encouraging to see the Federal Reserve looking at innovative alternatives."