Essay: How Does Quantitative Easing Create Jobs?

Federal Reserve Chairman Ben Bernanke recently announced the central bank will now undertake open ended Quantitative Easing until the economy gets significantly better. Specifically he said: If we do not see substantial improvement in the labor market, we will continue our asset purchases.

Although the first two rounds of QE have failed (if they hadn’t there would be no need for a third) the Federal Reserve has now decided to go all in on its signature program. Instead of taking finite action and waiting to see the results, going forward the Fed will take action every month until we get lots of job creation. To see how all these “asset purchases” are supposed to create jobs, lets study the mechanics.

Quantitative Easing is a fancy way of saying printing money and using it to buy stuff. In this iteration, the Fed will buy securitized mortgages. So every month it will create $40 Billion out of thin air and give that money to the big banks in exchange for mortgage bonds. According to Ben, these actions will lower rates, spur the housing market and make stocks go up, and as a result jobs will be created.

The idea of lowering rates further being a major benefit to housing is farcical. Since the peak of the housing market 6 years ago, the interest rate on 15 year mortgages has been cut in half, from over 6% in 2006 to less than 3% today. Today’s rates are the lowest ever, but housing is still in the gutter. The reasons are obvious to anyone who has tried to buy a house. Unemployment is high, incomes are low, bank lending standards are tight, people’s credit histories have been damaged, and there is still a large inventory of foreclosures. If you didn’t qualify for a mortgage at 4% interest last year, you probably won’t qualify for a 3% loan this year, and rates falling to 2.5% going forward means nothing to you. Ironically not that long ago Fannie and Freddie, the same mortgage entities whose bonds the Fed will be buying, announced tighter lending standards.

As in the past, the Fed won’t be buying the bonds from issuers directly but rather through large anks. Its goal is to increase bank reserves to drive them to lend. But the banks already have record reserves and are not lending. If a record amount of something hasn’t worked at all, why would more of a record succeed?

The “rising stocks lead to more hiring” argument is foolish in the same way. Bernanke keeps telling us there will be benefits via the Wealth Effect, as in when people see their 401(k) rise in value, they will feel richer and spend more money. But anyone who followed that logic with the Wealth Effect of the stock market bubble in the 90s or the housing bubble in the 2000s got crushed, and individuals are not as naive as economists. They understand the difference between paper wealth and real wealth, now more than ever. They also understand that a stock market that can be rigged higher by a central bank can crash in a flash.

From the public companies’ point of view, making major decisions based on stock prices makes even less sense. By that logic, Facebook would be laying off employees now that its stock has fallen drastically since.  Also by that logic all the members of the Dow Jones Industrials would have hired hand over fist in late 2007 (when the index made its all time high) then fired their entire workforce less than a year later when the market crashed.  Stocks in general have doubled since 2009, but public companies have not done any significant hiring

To see why stock prices and hiring are not correlated, imagine yourself as the owner of a pizza shop. The economy has been bad, and people are buying less pizza, so you fire 2 of your cooks and reduce the number of pies you prepare. Suddenly, your cousin Ben wins the lottery and decides to give you $10,000 for a piece of your business. Now that you have another 10 grand in the bank, and your business is worth a bit more, are you suddenly going to hire back the 2 cooks to make more pies that nobody will buy? Or will you just put the money in the bank and wait for when demand returns? The stock market exists to help companies raise capital. With most stocks near all time highs and US corporations holding record cash on their balance sheets, access to capital is not the problem. Lack of demand is the problem, and no amount of financial manipulation is going to change that. What’s worse, if you are that Pizza owner with too much cash and not enough patrons, you now have your crazy cousin Ben to contend with. It turns out Ben has never run a business and has some very naive ideas.

To be sure, there are some benefits to lower interest rates and higher stocks, but those were realized long ago.  The question that any rational person should ask is if the first $3 trillion in Quantitative Easing has failed to do what the Fed forecast it would in terms of housing or employment, why should another $40B a month make a difference? Furthermore, there is the issue of the cost of these programs. The Fed keeps assuring us the costs are minimal, but can we trust it? Economics is the science of the personal, and any idea that makes sense economically should also make sense personally. So ask yourself if you believe you can get something for nothing.

Cousin Ben seems to think so.

 

 

 

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