QE3 Prospects

“Yesterday, when we presented the Bloomberg interview of Princeton economist and former Fed vice chairman Alan Blinder, we speculated that his statement that “more easing is necessary” was the first shot across the QE3 bow. Today, Goldman’s Sven Jari Stehn has fired the second one in a paper just released titled: “Fiscal Adjustment without Fed Easing: A Tall Order” in which he basically takes our conclusion from the Blinder interview to the next level. As Blinder said previously, in order to improve the once again deteriorating labor picture, more fiscal stimulus would be necessary. That, however, is impossible, especially in a Congress where everyone is now promising $4 trillion of deficit cuts over the next few years. The only difference is how this cutting will be achieved: republicans want spending cuts, while democrats are demanding tax hikes for the richest. While neither approach will work in the US without the shock of a bond-crash induced austerity, Goldman conducts an thought experiment in which it evaluates the effectiveness of a tax-based and a spending-based fiscal consolidation. While finding that on average spending based deficit reduction is more effective, it only truly works in parallel with assistance from monetary policy: be it an interest rate decrease (impossible due to ZIRP) or further Large Scale Asset Purchase (QE) program. In other words, the only thing that can prevent an economic contraction in the next 2 years of semi-austerity, will be more monetary easing.”

Full article