Should we worry about QE2?

My view is Quantitative Easing two QE2 is much ado about very little. The total amount is very small relative to GDP. It is even small relative to this year's Federal deficit! If the effects, good or unintended bad, are not very large, why bother? There are several reasons.

First, a major driver of an economy is confidence. If people feel the Federal Reserve will take any steps necessary to insure a double dip recession does not happen, investment decisions can be strongly influenced toward going ahead. This can easily add several points to the growth in GDP next year.

Second, the risk of short term deflation is greater than the risk of short term inflation. Deflation, if it goes on for too long can be terribly damaging to the public psyche in an economy. I'm not suggesting we are starting to look like Japan. What I am saying is the cost of getting out of a deflationary trap is huge. Inflation is more easily tamed in its early stages. It's not trivial but most people would rather have the problem of slowing an overheating economy down than reviving one that appears dead in the water.

What is the downside? There are a number of fear scenarios that I would be worried about if QE2 were much larger. The most discussed one is a lower dollar leading to import good and commodity inflation that would flair up into a generalized inflation. The point is nobody knows because distortions in the market, which this is, can manifest their side effects in unexpected ways. Things never follow the same path as the last time. Many people point to the 1973 oil price shock as an analog. I'm sure that won't happen but something else might.

The real worry is not just QE2 but the totality of the Federal Reserve's accommodative monetary policy. The concern is that the Fed might not tighten up monetary policy at the right time and at the right pace. Will they get it exactly right? Of course not. Will they be close enough? Everyone hopes so but no one will know until much later.

I like to compare QE2 to the cash for clunkers program. The costs and risks of both programs are relatively low, as are the tangible returns. But, they both create buzz. Buzz is what gets people excited.

Richard Ellis PMP PRM
www.linkedin.com/in/richardellis86