3 Reasons The Fed Should Not Do QE3

We’ve seen just about everyone else’s opinion on QE3 in recent days (see here and here) so I’m going to put my head on the chopping block here again (I’ve had a decent string of successful calls on these Fed meetings, but my luck has to run out eventually, right?) and try to predict the madness of central bankers.  Here’s my thinking on QE3 as if I were sitting in on the FOMC meeting advising Dr. Bernanke on where we should go next.

Here’s where we are.  The economy is weak.  Everyone knows it.  Unemployment is far too high.  Inflation is not a big concern, but slightly above our target.   The stimulus doesn’t seem to have helped a huge amount, but no one knows for sure.  The economy appears to be showing some signs of life in the real estate sector, but we can’t hang our hat on another housing recovery to drive us out of this rut.   The government needs to do more and we aren’t completely out of ammo (at least we don’t think so).  That’s the 30,000 foot view.  Let’s take a closer look:


  • The Fed is an independent entity and seeks to avoid politicizing its role in the economy.  There is nothing more political in America than a Presidential race.  So the Fed has to tread very carefully here.  Does recent economic data really warrant appearing political and implementing what will be viewed as a hugely important stimulative package just weeks before a Presidential election?  I don’t think so.  We can afford to wait and the prudent thing to do is to wait.
  • Core inflation remains above the Fed’s comfort zone.  Inflation is not a concern, but by the Fed’s measures we’re failing on both the price stability AND the unemployment front.  Clearly, we aren’t having a huge impact on the unemployment front, but the effect of QE on inflation is less clear.  With core inflation at 2.1% we’re over our target of 2% and at risk of tipping above that if QE is implemented.  Again, this indication says we can afford to hold off.
  • The signalling effect is just about the strongest tool the Fed has left.  So far, the threat of QE3 has appeared to have a very strong signalling effect.  The Fed really believes in the wealth effect and the positive influence of rising asset prices so milking this signalling effect for all it’s worth is another reason to hold off.  If the portfolio rebalancing effect and the wealth effect are two of the primary transmission mechanisms for QE then let’s keep market participants staring at this bazooka on the table for as long as we can.

All in all, there are signs that the economy is stronger than some suspect and the above three points give us reason to hold off for another few months.  We meet again October 23-24 and then again in December so that’s ample time to assess more data, avoid appearing political in front of the election and keep the markets staring at this nice big bazooka we have placed on the table with QE3.

My recommendation to the FOMC would be to hold off.  The December meeting is an obvious time to implement QE3 and from a strategic perspective it makes a great deal more sense to implement the policy then.

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