The latest edition of quantitative easing (QE3) is yet another instance of Federal Reserve Chairman Ben Bernanke’s courage to risk inflation in the future for the sake of growth now. But it is unlikely to succeed, as was the case with the earlier two versions. US commercial banks are swimming in liquidity for lack of lending opportunities and rising risk aversion. Banks’ total cash reserves amounted to $1.55 trillion on September 5, 2012, of which 93.5 per cent was excess. Besides the reluctance to lend, banks find the interest of 0.25 per cent on total balances with the Fed more attractive than investment in Treasury Bills. As on September 14, 2012, the yields on one-month, three-month, six-month and one-year Treasury Bills were 0.08, 0.11, 0.13 and 0.18 per cent, respectively.
Aggregate deposits with FDIC-insured* institutions stood at $10.32 trillion, as on June 30, 2012, an increase of 5.7 per cent from the year-ago quarter and 20.4 per cent from the level four years back. But aggregate loans were at $7.51 trillion, only 2.7 per cent up from the year-earlier quarter and down six per cent from four years ago. The credit-deposit ratio was 72.8, compared with 74.9 one year ago and 93.3 four years ago, telling the story of meagre lending growth despite low rates and government programmes designed to boost lending activity like TARP (the Troubled Asset Relief Programme) and the Small Business Lending Fund.
What can an easy monetary policy do in this situation? QE3 will only result in a further round-tripping of funds to the Fed. It is a moot point whether the strategy to effect a reduction in long-term rates through Operation Twist will help spur domestic investment in the absence of confidence in the economy’s future on the part of the average citizen and the corporate sector. The unemployment rate remains at a stubborn eight-plus per cent. A good proportion of the money pumped into the economy flows abroad, seeking better returns with the result that the Fed’s QE is creating more employment opportunities and inflation in other countries, especially in commodity markets, than in the US.
Elasticities of imports and exports
I have tried to work out from the inter-industry or input-output tables, pioneered by the Russian economist Wassily Leontief, what proportion of a dollar injected into the US economy by the central bank is spent domestically giving rise to the income multiplier effect, ignoring the leakages in the second and subsequent rounds. I have not succeeded because of the insurmountable limitations of the matrix. In the tables intermediate inputs record the sum of imported and domestically produced goods, whereas the researcher needs separate data for them.
There are, however, studies of the past that deal with the problem in an indirect manner. The seminal study of H S Houthakker and Stephen Magee in 1969 estimated the US income elasticity for total imports at 1.7 and the foreign income elasticity for US exports around 1.0. An article in Volume 1 of the Working Papers series of the Peterson Institute for International Economics (2006) says subsequent studies estimate import and export elasticities higher than the original findings but, surprisingly, the ratio of import to export elasticities varies relatively little from the 1.7 found by Houthakker and Magee. Briefing the Trade Deficit Review Commission on August 19, 1999, Catherine L Mann of the Institute said the import intensity of government output was about 17 per cent, whereas the import intensity of consumer spending on goods was about 58 per cent, and the import intensity of investment spending on goods was about 50 per cent. One may assume that the situation has not changed much given the continued high current account deficits.
The way out
The way out of the logjam is fiscal. What the country needs is a massive public works programme that will employ not only manual but intellectual labour also on a larger scale than what was attempted in President Roosevelt’s New Deal. There are segments of the nation’s infrastructure that cry out for renovation and reinvention. During the Great Depression industry dominated the economy. But today it is the service sector that contributes the major proportion to growth. It points to the need for developing skills through education, training and so on. The US pioneered the concept of a career change in middle age. It should not be difficult to plan and execute a skill development programme that could facilitate an employee, say, in an automobile factory to learn and practise as an information technologist or a para-medical worker or a teacher, given the minimum general educational qualification needed for absorbing training. There is a vast reservoir of potential job creation in such services as nursing that can be learnt easily and in a short time. The gap is now filled by immigrants.
Last, but not least, the country needs to find ways of producing goods and services less expensively. The US continues to be an energy guzzler. The long-term solution lies in raising productivity through research and development. President Obama’s plan for job creation seems to be too little and too late. Of the $447 billion proposed to be spent, against the required $1 trillion according to some experts, less than a half are for projects of the type to which I have referred. Cynics have said Obama’s plan will produce only one job — his re-election!
* FDIC stands for Federal Deposit Insurance Corporation. It is an independent agency of the US federal government that insures bank deposits for at least $250,000.
The writer is an economic consultant and a former officer-in-charge in the department of economic analysis and policy at the Reserve Bank of India