A third bond-buying program by the Federal Reserve—or quantitative easing, as it's commonly called—is likely to resume by the end of the year or in early 2012, Goldman Sachs economists said in a report Wednesday. The forecast comes on the heels of the Federal Reserve's announcement Tuesday that it would keep rates steady at near-zero levels for the next two years.
"We have changed our call because [Tuesday's] statement suggests that the committee's reaction function to incoming economic news is more dovish than we had previously thought," said the report, which also cited remarks by the Federal Open Market Committee that it would employ additional policy tools if economic conditions deteriorated further.
While this might be welcome news for jittery investors clamoring for Fed intervention to help boost market confidence, experts caution that another round of quantitative easing wouldn't be a panacea for the ailing U.S. economy. Some critics say it would likely amount to just another Band-Aid on the economy's skinned knees.
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For starters, the global economic landscape is drastically different than it was when the Fed launched its second quantitative easing program, QE2, in November 2010. Since then, a series of temporary shocks—a catastrophic earthquake in Japan, debt-ceiling drama in Washington, and the sovereign debt crises in the eurozone, coupled with more fundamental economic maladies—have rocked the global financial system to its core. "The old rules we judge the economy by, the old rules we tried—they may not be completely applicable anymore," says Diane Swonk, chief economist at Chicago-based Mesirow Financial.
The challenges policymakers face differ tremendously as well. Back in 2010, deflation was the crisis of the moment, with markets fearing an unavoidable downward spiral of lower prices, weak demand, and massive lay-offs. Despite the many critiques leveled at the bond-buying program, QE2 seems to have staved off deflation, preventing a vicious cycle that could have plunged the United States into an even deeper recession.
Inflation is now the enemy. Through June, the Consumer Price Index (CPI), which measures the average change in prices of goods and services over time, has increased 3.6 percent over the past 12 months, according to the Bureau of Labor Statistics. (July's CPI is due next week.) At this time last year, the CPI was increasing at an annual rate of 1.1 percent. Core inflation—the index for all items, less food and energy—edged up to 1.6 percent in June, its highest reading since January 2010. (This measure is more closely tracked by the Fed.)
"QE2 prevented deflation, which would have been really bad for the jobs situation," says Guy LeBas, chief fixed-income strategist at financial-services firm Janney Montgomery Scott. "Right now the risk of deflation is pretty slim, so there's really no need to expand the [Fed's] balance sheet."
While the economy might have sidestepped a deflation disaster for the time being, a host of other grave economic problems confront the country, the most pressing being less-than-stellar growth over the past few years. According to recent government figures, GDP grew a meager 1.3 percent in the second quarter, revised downward from initial estimates of almost 2 percent. That figure comes on the heels of a stunningly low 0.4 percent GDP growth rate in the first quarter of the year. Exacerbating a situation already rife with uncertainty and angst, the debt-ceiling drama concluded with the first-ever downgrade of U.S. debt, sending shockwaves through equity markets worldwide.
The situation across the pond doesn't look much better. With much of Europe facing rampant public debt problems and equally serious, if not worse, projections for economic growth, investors are on the defensive, fleeing to ultra-safe investments and even cash, draining global equity markets and depressing business confidence and investment.