By Marshall Auerback
Yesterday, Ed wrote a good piece on consumer spending and the return of the economy to the status quo ante. I think it’s a little bit more malign than that.
There has been a real positive change in the underpinnings of this economic recovery and it all derives from the “consumer conundrum”. It strikes me that the US consumer has got some "savings fatigue" and the budget deficits had facilitated some deleveraging and build-up of savings, which clearly is being drawn down now to re-start this consumption. But this is still inherently private debt constrained, which is why it is not sustainable in my view without employment growth.
Also, bear in mind that consumer spending strength was all at the “high end”, as Ed has pointed out many times. I think this strong consumer performance was probably in part stock market related. And stock market strength was clearly QE2 related. However, the mechanism by which this happened is not at all clear. Remember, the Fed has argued that QE works through the ”portfolio balance channel” by lowering long-term interest rates and thereby lifting the stock market, housing activity, and corporate spending. However, in the fourth quarter the long-term rate of interest rose, and by a considerable amount. It was therefore not responsible for stock market strength. It was not responsible for housing sector strength, as all housing sector measures were flat to down. Home prices fell. It was not responsible for a corporate spending splurge; capital spending was up at only a 4% rate which is a low rate for this GDP component in an economic recovery. Also, corporate cash flow and cash balances have been so high that the long-term rate of interest probably now has little relationship to corporate spending. In other words there is no obvious traditional direct economic relationship between QE and the fourth quarter splurge in consumer spending and overall real final sales.
It is my position that the Fed is succeeding with QE largely through the psychological impact of its “rhetoric” or “expectations management” or whatever you want to call it. In other words, it is succeeding largely through the encouragement of belief on the part of market participants that it will move heaven and earth to get the stock market up. The Fed is pulling the economy up by its bootstraps by fostering mega moral hazard. Maybe employment and income will follow. But for now the improved economic recovery is based on Fed conjured psychological effects more than anything else. And that’s why I am a long term sceptic.