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The Economist: The dirty little secret

Tucker Hart Adams //January 1, 2011//

The Economist: The dirty little secret

Tucker Hart Adams //January 1, 2011//

There’s a dirty little secret out there: No one can provide a quick fix for the economy. Not the president. Not the new Republican Congress. Not the Federal Reserve. It took us a long time to get into this mess, and it is going to take a long time to get out of it.
That said, there are clear signs the economy will look better in 2011:

Third quarter output data were revised up in November.
Exports are rising, as the recovery accelerates in developing nations such as China, Brazil and India.
Consumers are more optimistic and are spending a bit more freely, albeit still looking for bargains.
People are traveling more, and the lodging tax in metro Denver is rising at a double-digit rate.

It doesn’t take a lot to make us feel better these days. I had to smile when the good news about small business a few weeks ago was zero job growth. At least that’s better than the more than a year of job losses that preceded it.

One question that seems to be on everyone’s mind is the Federal Reserve’s new program of quantitative easing, or QE2. The more pessimistic savants argue that it is more likely to be T2, a repeat of the Titanic disaster.

In reality, QE2 isn’t that different from the
actions the Fed normally uses to influence interest rates and the economy. The difference is that rather than buying or selling the shortest Treasury
maturities to affect short-term rates, the Fed is going to buy intermediate term securities (three- to five-year Treasuries) to keep longer rates low. The hope is that this will encourage businesses and consumers to borrow (and banks to lend!), creating jobs and economic growth.

The lack of job growth is the biggest problem facing the U.S. economy and the reason the last 18 months haven’t felt like a recovery. The “true” unemployment rate, which includes discouraged workers and those who can only find part-time jobs, remains around 17 percent for the nation and 15 percent for Colorado.

The primary reason the reported unemployment rate isn’t at a double-digit level is that people became discouraged and stopped looking for work, thus ceasing to be unemployed by the Department of Labor definition. Soaring enrollment at Colorado’s community colleges provides a stark reminder of what is occurring.

Why do financial experts argue that QE2 can be a bad thing, in the face of the jobs problem? There are two primary reasons.

The first is that it will cause the value of the dollar to fall against other currencies, making our imports more expensive. That is likely to be a side effect of the action, but it isn’t all bad. More expensive imports will encourage us to buy less from abroad and perhaps save more and/or buy more goods produced domestically. It will also make our exports cheaper, keeping our factories busy and creating jobs at home.

But that is not the Fed’s purpose. Its mission is to focus on low inflation and full employment. There seems to be concern among the Fed’s Open Market Committee that, with core inflation (the one you care about if you don’t drive, eat or heat your home) below 1 percent, we could actually slip into a period of falling prices or deflation.

This would encourage people to delay purchases, waiting for lower prices. It would also make debt more difficult to handle, since debt doesn’t decline with the price level. Salaries, however, do.
The most strident critics of QE2 believe that it is rampant inflation – not deflation – that we need to worry about. That is a valid concern, but only a very long way down the road. When the recovery is well under way and banks are anxious to make loans, the huge quantity of reserves the Fed is pumping into the system may be a problem. However, they believe they have the tools they need to drain those excess reserves from the system before they do harm.

The recovery, although well under way, is slow and fragile. Congress, the Fed and the president all need to support it. The programs in 2008 and 2009, although not perfect, prevented a repeat of the Great Depression. Hopefully those undertaken in 2011 will do more good than harm.

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