Epsilon Capital Management Economy ReviewsThe huge fiscal and monetary stimulus dispensed in recent years has staved off theonset of chronic deflation. For now.The deficits created by this spending would be inflationary only if the measures occurredin a period of full employment and created excess demand. That isnt the case in theUS, where the large budget shortfalls are a response to private-sector weakness that hasdepleted tax revenue.Indeed, even with persistent trillion-dollar deficits and huge monetary-easingprograms, the slack we see in the economy reflects the huge size and scope of theoffsetting deleveraging in the private sector that I noted in yesterdays column.Monetary Stimulus: The Federal Reserve and other central banks have been extremelyaggressive. First, the Fed pushed the short-term rates they control to almost zero - withlittle effect. Then it turned to quantitative easing, the enormous purchases of governmentbonds and other securities that have been tried by the Bank of Japan for years withoutnotable success. The Fed, with its dual mandate to promote full employment as well asprice stability, is using a very blunt instrument to try to create jobs.The central bank can raise or lower short-term interest rates, and buy or sell securities.Those actions have little to do with creating more jobs. In contrast, fiscal policy can besurgically precise, aiding the jobless by extending and expanding unemploymentbenefits.
Mortgage RatesThe Fed is now buying residential mortgage-related securities as a way to push downmortgage rates and spur housing. But the effect of these measures has been largelyneutralised by a number of negative forces, including tight lending standards, low creditscores, "underwater" mortgages, uncertain job security or unemployment and theawareness of consumers that for the first time since the 1930s on a nationwide basis,house prices have dropped substantially and could do so again.Nevertheless, the Fed is relying on five interlocking steps to increase job creation: First,the central bank buys Treasuries or mortgage-related securities. Second, the sellersreinvest the proceeds in assets such as stocks, commodities and real estate, pushing upprices. Third, higher asset prices have a real wealth effect by making investors feel richer.This, in turn, leads people to spend on consumer goods and services, as well as capitalequipment. And last, that spending spurs production and demand for labour.So far, it hasnt worked as planned. Despite recent improvements, the US unemploymentrate, at 7.7 per cent, remains very high by historical standards, particularly more than 31/2 years after the trough of a recession. And cautious employers have turned totemporary workers who generally are paid less and are easier to dismiss than full-timeones.Temporary, Limited Effects: Every round of easing by the Fed has been accompanied bya jump in stocks that lasted only until the next crisis in Europe or the US In addition, thegross-domestic-product bang per buck of new debt isnt what it used to be.