There's One Influential Economic Policy Rule That Says We Should Have QE3

Larry Fink

Photo: BlackRock

The Fed is indicating that there’s no QE3 coming and that rates will stay low, and many people are saying that they are expecting the same.

But there’s one economic policy rule that disagrees with them all.

The Taylor Rule says that we should LOWER rates right now.

The Taylor rule is a monetary-policy rule that says how much the central bank should change the interest rate in response to changes in three key variables: the inflation rate, GDP growth, and the interest rate. Basically, it’s a formula that says that if inflation rises 1 point, interest rates should also rise at least 1 point to cool the economy down. 

It looks like this (via Wikipedia):


The Fed doesn’t necessarily follow the Taylor Rule, but it’s considered influential. Goldman Sachs pointed to the rule last week and said that, “we would need to see about a 3/4 percentage-point decline in the unemployment rate forecast or a 1/2 point increase in the inflation forecast for the rule to project any monetary tightening.”

Plugging in all the variables (via a Bloomberg Terminal), we eot that the current Federal Funds rate should be -0.60%, implying an effective Federal Funds rate cut of 85 bps, because the current rate is 0.25%.

The Taylor Rule is making a pretty good case for QE3.

However Goldman Sachs is disregarding the contradiction. Analysts at the firm write, “Our analysis implies that it would take a 1 1/4 point increase in the unemployment rate forecast or a 1 pt drop in the inflation forecast for additional easing moves.”

And Steve Schwarzman, Brian Moynihan, Larry Fink, and David Tepper are all pretty much in agreement, too. Each of them told CNBC in the last few weeks that they aren’t expecting a third round of money printing this year, as you’ll see below.

Schwarzman: “I always find it fascinating that when things start happening, people start reacting as if they were never told it was going to happen… I sort of look at QE2 as something that is more or less in people’s expectations, and we’re not positioning ourselves for some short-term operation of that type.”

Moynihan: “We’re such a huge economy that we’ve got to make sure this economy stays moving the right direction. So it still grows. Everything we see still sees that growth. I think our view is that rates stay pretty low for a long time because this is a big economy, and it’s going to continue to crawl forward.”

Paul Dales, the senior US economist at Capital Economics: “Given that the slowdown could be due to temporary factors, that the imminent threat of deflation has eased and taking into account the mixed results of QE2, we see little prospect of QE3, at least not this year.”

Larry Fink: “I don’t see any reason to think we need a QE3.” 

What the Taylor Rule suggests might be that there’s a big HOWEVER at the end of what everyone’s saying, which David Tepper alluded to.

Tepper: “Bernanke said no QE 3…there is no QE3 coming down the pike [and it makes for a] difficult investing environment… Maybe if the S&P is down a couple hundred points, they would reconsider.”

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