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VOL. 38 | NO. 45 | Friday, November 7, 2014

Rising GDP allows Feds to fold quantitative easing

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Nearly five years after the conclusion of the Great Recession, the U.S. Federal Reserve has chosen to conclude its quantitative easing program.

Ben Bernanke thought long and hard about the potential for Central Bank “emergency measures” like QE throughout his academic career. His devotion to Milton Freidman and the quantity theory of money (money supply * velocity = GDP) provided the orthodoxy for the U.S. response to the financial crisis.

Simply put, with monetary velocity in freefall, money supply must expand to prevent outright deflation and depression.

This transitive maxim generated boisterous debate in the economic community. Those in favor of the Bernanke bias drew upon the history of the Great Depression, when contractionary central bank policy amplified the nation’s economic misfortunes.

Those opposed referenced the runaway inflation episodes that have plagued profligate nations whose governments printed money to “monetize” debts, and the moral hazard consequences that frequently accompany massive marketplace interventions.

While the “unintended consequences” of ballooning the Fed’s balance sheet from $800 billion to $4.5 trillion have yet to appear, the “intended consequences” of deflation avoidance, asset appreciation, GDP support and orderly deleveraging have appeared.

The Europeans chose a different path. Haunted by the hyperinflation of the 1920s, the Europeans elected a much more cautionary monetary expansion to reduce the risks of “unintended consequences.”

In fact, then-ECB Chief Jean Claude Trichet actually increased lending rates in 2011, choking off the recovery and exacerbating the Euro crisis.

Recognizing this folly, the ECB quickly reversed field, and rates have been on a steady downslope ever since. Furthermore, the ECB largely resisted U.S.-style quantitative easing (again to ward off “unintended consequences”), yet seems poised to reconsider as deflation persists.

The German aversion to “unintended consequences” has eschewed the “intended consequences” that the Bernanke Fed achieved. The juxtaposition of the abundant Fed response with the austere ECB response settles the argument for now. QE worked.

Perhaps at a later date, the “unintended consequences” will arise and overturn our appreciation for the program. For now, we offer a grateful but tempered farewell.

Now that the Fed has actual experience administering QE, it may be seen as a less-exotic and more conventional policy. In the aftermath of the crisis, the Fed’s playbook has expanded ... and so has their willingness to use it.

Yippee GDP! The end of QE indicates that the Fed believes that the U.S. economy has reached escape velocity. Fortunately, the recently released third-quarter GDP report agrees. The U.S. economy grew 3.5 percent last quarter, though it’s likely to get revised downward. Expect fourth-quarter GDP to be lower still.

David Waddell, who is regularly featured in the Wall Street Journal, USA Today and Forbes, as well as on Fox Business News and CNBC, is president and CEO of Memphis-based Waddell & Associates.

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