Will Further QE Help or Hurt the Economy?

Last week, the Fed decided to extend the Operation Twist through the end of the year and reiterated that it is prepared to take further action if the economic conditions warranted.

Many market participants still expect that FOMC will announce additional quantitative easing (QE3) at its August meeting, if the economic data (in particular the June employment report to be released on July 6th) continues to be weak. 

At the same time, it is not clear whether increasing monetary stimulus will be able to make substantial difference for economic growth. The long-term effects of continued ultra-loose monetary policy on the economy remain subject to debate.

The Bank for International Settlements (BIS-the central bank of central banks) recently warned that many central banks are providing monetary stimulus on a massive scale but these measures could have undesirable side effects if continued for too long.  

According to the BIS, three main risks of prolonged monetary easing are:

  • It makes necessary fiscal and structural adjustments seem less urgent;
  • The financial sector hit by low returns, may take higher risks in search of higher yields;
  • The central banks may find it difficult to implement the tightening of the monetary policy when that will be required and that in turn could produce another credit bubble.
It is a fact that the governments and the market expect the central banks to act as the policymaker of last resort, which takes the pressures off the governments to take adequate measures to correct their fiscal problems.

In his recent testimony before the Joint Economic Committee, the Fed Chairman had warned: "the so-called fiscal cliff--would, if allowed to occur, will pose a significant threat to the recovery. Moreover, uncertainty about the resolution of these fiscal issues could itself undermine business and household confidence". And, "the economy's performance over the medium and longer term will depend importantly on the course of fiscal policy".

Do you think that the Fed has already done whatever it needed to do to stimulate the economy and it is now Government's turn to act? And continued reliance on monetary stimulus will only create long-term imbalances in the economy?

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