HEADING TO THE EXIT / THE FINANCIAL TIMES EDITORIAL

September 20, 2013 6:21 pm

 

Heading to the exit

 

No good options as Fed weighs end to quantitative easing

 

 

When the music stopped in financial markets in 2008, the Federal Reserve struck up a replacement tune. By buying assets with newly minted cash, it has driven down yields on government bonds and forced investors to take risks in search of higher returns.

 

This was intended to breathe life into the economy until a recovery could continue on its own. A diminuendo had been pencilled in for this month. Yet the Fed has instead decided to keep monthly purchases at $85bn. Finding a way out is proving harder than thought.

 

Although quantitative easing has lifted spirits, its effect has been more muted than some had hoped. Despite low funding costs, investment is in the doldrums. Governments are cutting deficits, households are repaying debt, and corporations are piling up cash.

Consequently, the money created by the Fed is not funding activity such as housebuilding or capital investment, which would contribute directly to growth. Instead, it is lifting the value of existing assets. This indirectly boosts output by making owners richer and more willing to spend. But it may not be enough to trigger a self-sustaining economic revival.

When the current round of easing was launched last September, Ben Bernanke, the Federal Reserve chairman, said it would continue until US employment data improved. Because capital markets are forward-looking, the open-endedness of this programme magnified its effect. For the same reason, this could quickly be reversed once an end is in sight. Markets may become more volatile as traders try to guess what each scrap of data portends for the Fed’s future actions.

Mr Bernanke had tried to make a graceful exit by signalling when, and how quickly, the Fed would withdraw. But his assurance that “tapering” would be gradual has not soothed markets as much as he intended. After funding costs increased in anticipation of a coming squeeze, Mr Bernanke stepped back from the slowdown in purchases that markets had been led to expect would begin this week.

Despite the audible sigh of relief in global markets, Mr Bernanke and his successor now face a conundrum. A sudden end to quantitative easing could imperil the recovery, especially if asset prices fall quickly enough to produce widespread insolvencies.

 

Yet if a gradual end is announced, a more sudden one will automatically ensue. Nor can this be pursued by stealth. If markets are kept in the dark, their behaviour will be dangerously unpredictable.

 

 

Copyright The Financial Times Limited 2013.