What $4.5 Trillion Can Do – But Not for You

By Karen Shaw Petrou

Following the Federal Open Market Committee (FOMC) meeting of September 19-20, Chair Yellen admitted that she really didn’t understand if the Fed’s $4.5 trillion portfolio had any role in the slow-go U.S. recovery.  Many have since remarked on the startling fact that the Fed to this day is not sure if quantitative easing (QE) works and, if it does, how.  And, despite all this uncertainty, the Fed appears bent on keeping at least a few trillion in its hands just in case – presumably even if it didn’t work this time around, maybe it will the next time the U.S. economy needs a bit of a boost, or so the Fed seems to think.

As the Fed starts a very tentative reduction in QE and keeps all its options open to restart it at anytime, the burden of proof for QE going forward must fall on the Fed.  Calling QE to account means looking not just at markets, but also at economic equality – for all the questions about QE’s macroeconomic impact, its role in making Americans still less equal is painfully clear.

Reflecting Chair Yellen’s quandary, QE proponents generally speak of it only with faint praise.  Conventional wisdom dubs QE a qualified success if the Fed is able slowly to shutter QE without a market crisis.  This rationale is grounded on the assumption of a U.S. recovery that would have been still slower and lower without the Fed’s intervention.  However, research I have released makes it clear that, even though the Fed may well have protected market stability and stoked a bit of growth, it has played a strong role making the richest Americans even richer.  This not only deepens the gulf between most Americans and prosperity, but also exacerbates political tension and creates new financial-stability risk.

As our research shows, QE exacerbates inequality because it takes safe assets out of the U.S. financial market, driving investors into equity markets and other financial assets not only to place their funds, but also in search of yields higher than those possible with ultra-low rates.  The Fed hoped that soaking up $4.5 trillion in safe assets would stoke lending, and to a limited degree it did.  However, new credit largely goes to large companies and other borrowers who have used it for purposes such as margin loans and stock buy-backs, not investment that would support strong employment growth.  Growing household indebtedness in the U.S. is principally consumption or high-price housing driven and thus also a cause – not cure – of inequality.

Although the Fed thinks U.S. employment is “full,” the latest census data show that U.S. median household income in 2016 rose in part because more families have more wage-earners.  Two low-wage jobs may seem like more employment, but they are reflecting the ever-greater struggle lower-income Americans have making ends meet.  Without the recent boost in employment, lower-income households would be still worse off, but economic inequality is little offset, if at all even as still more damage is done to the social-welfare fabric.

QE’s adverse equality impact is wholly unintentional, but nonetheless measurable and all too meaningful.  It comes in concert with two other policies under the Fed’s control that also inadvertently but inexorably exacerbate economic inequality:  ultra-low rates and the sum total of all the post-crisis rules.  Prior research has also assessed this, as will numerous blogs in this series. 

Given the magnitude of U.S. economic inequality and its many causes about which little can be done, it is incumbent on the Fed to acknowledge its inequality impact and reduce it wherever possible.  QE may not be the only problematic policy, but it’s the one the Fed understands the least, has the fewest clear positive effects, and can be far more quickly reversed than the Fed now plans.