While the Fed mulls more ambitious plans to tell the public how it will steer the economy in the future, perhaps the monetary authorities should reflect on the results of their recent efforts. As notes long-time Fed watcher Lacy Hunt of Hoisington Investment Management in Austin, Texas, the unintended consequences of its policies have all but superseded their professed aims. For instance, QE2—the Fed’s purchase of $600 billion of Treasury securities completed in June—caused the current slowdown instead of giving the economy a boost, he writes in Hoisington’s Quarterly Review and Outlook. Real disposable income was lower in August than in December, in part because of the jump in commodity costs. “While rising equity values helped a few consumers, inflation in necessities, such as food and fuel, decimated real incomes for the average family. Thus, the emergent cyclical weakness that lies ahead can be directly related to the unintended consequences of quantitative easing,” Hunt says.Pretty ugly stuff, and I fear all too accurate.
The Fed’s current policy of attempting to flatten the yield curve by buying long-term Treasury securities and offsetting it with sales of shorter-dated paper—Operation Twist 2.0, after a similar gambit in the early 1960s—also could backfire. The FOMC minutes said the policy was expected “to help make broader financial conditions more accommodative.” Translated from Fed speak, lower long-term rates will make borrowers more willing to borrow while lenders will be more eager to lend.
But, Hunt points out, ultra-low interest rates could have the opposite effect. To earn a profit, banks have to cover their costs, from payroll, overhead, taxes and “elevated” fees to the Federal Deposit Insurance Corp. Then they have to earn a spread to compensate for the risk the borrower could default. At very low interest rates, there aren’t enough basis points left to lend profitably. The historical precedent is Japan, where banks would rather buy government bonds than make loans . . .”