Why the Economy Didn't Crash
WHY YOU SHOULD CARE
Because this is what’s been going on for the last six years to save your wallet.
By Chris Pummer
Monetary policy is as esoteric as it gets. So it’s understandable that the vernacular and the substance alike are unappreciated by the millions these high-level decisions affect — even when these policies are instrumental in staving off economic collapse. But if you’re wondering why we’re not in an all-out depression right now, the answer lies deep in the belly of a wonky policy dreamed up by those old economic puppeteers at the U.S. Federal Reserve. A policy that went gently into that good night just a month ago, and which has been mourned by few since.
But start at the beginning: Six years ago, during the financial crisis of 2008, the Fed launched its so-called quantitative-easing initiative, nicknamed “QE,” which was an attempt to get the nation’s economy flooded with cash — cash that the Fed essentially creates out of thin air. When neither President Barack Obama and Congress nor even the Fed itself — which tried cutting interest rates to historic lows — could whip the economy into shape, the Fed brought out a more entrepreneurial, lesser-used tool: QE. The strategy made splashy headlines on the business pages but left most everyone else baffled.
Since the start of 2014, the wide conjecture has been not if but simply when QE would be laid to rest; it’s lived six years already and has long been fairly controversial, not least because it involved the Fed dropping a cool $3.6 trillion to buy government bonds. Now the question is, in retrospect: Has it been successful? And that’s no casual counterfactual musing — knowing the answer means unlocking the clue to what can fix or save our economic machine.
Most importantly of all: It seems like QE worked to stave off a depression.
Some say a clean “yea” to the policy’s success: “Even though it ended with a whimper, QE was an amazing experiment,” said David Wessel, director of the Brookings Institution’s Hutchins Center on Fiscal and Monetary Policy. “What remains yet to be seen is how effective the medicine has been in terms of the patient’s continued recovery.” But not everyone would have characterized it as medicine. Others might have called it poison.
QE: The Biggest Gamble in Recent History?
Understanding the risks and potential ramifications that went with QE — let alone the fallout still to come — means recalling the magnitude of the economic cardiac arrest the U.S. and the world suffered in 2008. Governments have two options to combat an impending depression. There’s the fiscal approach, in which the president and Congress boost government spending on multibillion-dollar initiatives, such as jobs-creation programs, to ease unemployment (the Democrats’ New Deal-style remedy). Or there’s another option: deep tax cuts to encourage the wealthy to invest more (the Republicans’ read-my-lips preference). Both drive up the federal budget deficit in the present and the federal debt for years to come.
An effective solution from the left never materialized: After gaining a majority in the 2010 election, the Republican House argued against, and ultimately stymied, Obama’s attempts to revive the economy with massive spending; at the same time, the Republicans lacked the clout to get its own solution — tax cuts — passed. History will brand Obama and GOP House leader John Boehner alike as weak leaders in crisis for failing to compromise more. A compromise ”would have carried us much further,” said Jeffrey Frankel, professor of capital formation and growth at Harvard’s Kennedy School of Government. “Because fiscal policy was so screwed up, it put more of the burden on monetary policy.” In other words: Obama and Boehner effectively jettisoned the problem straight onto former Fed Chairman Ben Bernanke’s shoulders.
Enter Bernanke, the former Princeton professor held over from the W. Bush days. He’d already started deploying a monetary offensive in the midst of the collapse by cutting interest rates to near zero percent, hoping to spur demand. By November 2008, the federal funds rate fell below 0.25 percent for the first time in history (where it stands even today). “No economist would ever have imagined when rates went to near zero in 2008 they’d still be there six years later,” Wessel said. Along with cutting the fed funds rate, the Fed opened up a new front that same month with the rare QE, a stimulus tried only once before (by Japan in 2001-2006, with little measurable success).
Somehow we don’t appreciate how good things are.
— Jeffrey Frankel, professor of capital formation and growth at Harvard’s Kennedy School of Government
Rather than just buying short-term U.S. Treasury bills — the means by which it sets interest rates normally — the Fed began buying longer-term Treasury bonds and mortgage-backed securities. The goal: To drive down long-term interest rates to encourage businesses to invest and consumers to spend on major purchases, whether buying cars with six-year loans or homes with 30-year mortgages. Most importantly of all: It seems like QE worked to stave off a depression; economists generally agree the first of three U.S. phases of QE initiated helped toward attaining that goal.
Good Riddance or Rest in Peace?
Here six years later, the economy has not only recovered but is also in robust — though plodding — expansion. The labor market has seen its longest string of 200,000+ monthly job gains in history, the federal budget deficit as share of GDP has fallen by the largest percentage ever, the median U.S. home price is near its 2006 high, auto sales are back to record levels and the U.S. stock market is at all-time highs. “Somehow we don’t appreciate how good things are,” Frankel said.
So do we have QE to thank for all that? Economic scholars will be researching and debating its effectiveness for decades to come, just as they did the causes and potential untapped solutions for the Great Depression for nearly a half-century. According to George Selgin, senior fellow at the Cato Institute, the lingering knock on QE is that it primarily enriched the wealthy, who benefited from the Fed purchases and the resurgence of the U.S. stock market. “The vast majority of benefit went to high rollers in financial markets,” Selgin said. “In that respect, it was fiscal policy disguised as a monetary policy with the idea the profits would trickle down.”
Yet QE’s efficacy as an economic reviver is being modeled outside the U.S. Japan recently reinstituted a QE regimen, a development that sent U.S. stocks soaring, and the European Central Bank is moving toward a QE program to reinflate its members’ ailing economies. And so Americans should say: Fare thee well, QE, for those nations that resurrect you. With all due respect, may the ominous need never arise for your return.
- Chris Pummer, OZY AuthorContact Chris Pummer