Prominent professors at Ivy League schools including Stanford, Princeton, and Northwestern University concur that quantitative easing policies have failed to restore pre-crisis employment and economic output. Robert E. Hall from Stanford University notes that the U.S. and other developed market economies have implemented expansionary monetary policy for five years without significant employment or economic output improvement. While the unemployment rate has declined from 10 percent in October 2009 to 7.3 percent in August 2013, the labor participation rate has also declined from 66 percent to close to 63 percent in the same period. Such trend suggests that people are discouraged about job prospects and are opting out of looking for employment. The study was noted in a recent presentation by Lacy H. Hunt Ph.D. of Hoisington Investment Management, obtained by ValueWalk.
Quantitative easing has failed
Furthermore, most of the employment gains have been in low paying sectors like hospitality, seasonal, and part time opportunities compared to the full time jobs lost during the recession. Low investment by businesses and low consumption have hampered output demand and negative real interest rates. The chart below shows that real GDP growth in the last decade has been a little below 2 percent and that real GDP in the first half of 2013 has only improved by 1.56 percent, well below the long term average of 3.8 percent. Hall argues that central bankers should focus on increasing capital requirements at banks and more rigorous stress testing. Such focus will likely reduce the need for the Federal Reserve to expand its own reserves to finance quantitative easing. Expansion of central bank reserves can have a constraining effect on economic growth by weakening demand of purchases financed by credit.
Effectiveness of stimulus
Hyon Song Shin of Princeton University contends that high leverage and a large banking sector were key drivers of the 2008 financial crisis and he has serious doubts about how effective central bank asset purchases are in driving consumption and investment. He does not believe that policymakers’ forward guidance will be effective at keeping long term interest rates low. Arvind Krishnamurthy (Northwestern University) and Annette Vissing-Jorgensen (University of California – Berkeley) found that the Federal Reserve’s Treasury portfolio purchases had little effect on interest rates across all fixed income markets, with the exception of mortgage backed securities. The study only considered announcement effects, which may not measure the full impact of monetary policy. Both Krishnamurthy and Jorgensen pointed out that the lack of a specific exit strategy from the asset purchase program could limit its effectiveness, as it increases uncertainty among market participants who do not know conditions that will prompt a reversal from accommodative policy.
Negative effect on economic growth
A study by Bergh and Henrekson in April 2011 that comprised a survey and interpretation of evidence of government size and growth used total taxes or total expenditures as a percentage of the country’s GDP instead of measuring general gross government liabilities as a percentage of GDP. With this method, Bergh and Henrekson concluded that there is a significant negative correlation between government growth and GDP growth. Particularly, an increase in government size by 10 percentage points is associated with a lower 0.5 to 1 percent annual GDP growth rate.
Checherita and Rother investigated the average effect of government debt on per capita GDP in twelve euro area countries over a period of almost four decades beginning in 1970. They found that a government debt to GDP ratio above 90-100 percent has a detrimental effect on long term economic growth. Furthermore, the negative effect on growth as the debt level rises beyond 90-100 is nonlinear, meaning that as government debt rises, the declines in economic output accelerate. Results “show a highly statistically significant nonlinear relationship between the government debt ratio and per capita GDP for the 12 pooled euro area countries included in their sample.” The Checherita and Rother 2010 study also suggested that negative GDP growth effects related to high government debt to GDP ratios start at 70-80 percent, and both scholars recommend more conservative debt levels. Checherita and Rother noted that the channels through which government debt levels impact economic output are private saving, public investment, total factor productivity, and sovereign long term nominal and real interest rates.
Excessive private credit can also hamper output growth
Several studies also show that certain levels of private indebtedness as a percentage of GDP can have adverse effects on annual output growth. In “Too Much Finance”, published by UNCTAD in March 2011, Jean Louis Arcand, Enrico Berkes and Ugo Panizza, find that when credit to private sector as a percentage of GDP reaches 104-100 percent output growth starts declining. The negative GDP growth effect is more pronounced at a private sector credit over GDP ratio of over 160 percent. Another study by Stephen G. Cecchetti, M S Mohanty and Fabrizio Zampolli done in 2011, “The Real Effects of Debt” determined that “beyond a certain level, debt is bad for growth.” The turning point when the negative effect of private debt on growth is more pronounced is at a private sector credit over GDP ratio of over 175 percent.
Minimal wealth effect
Sydney Ludvigson and Charles Steindel found a positive connection between aggregate wealth changes and aggregate spending. They noted in their July 1999 paper titled “How Important is the Stock Market Effect on Consumption” that “spending growth in recent years has surely been augmented by market gains, but the effect is found to be rather unstable and hard to pin down. The contemporaneous response of consumption growth to an unexpected change in wealth is uncertain and the response appears very short lived.” In their “Financial Wealth Effect: Evidence from Threshold Estimation” April 2011 paper, Sherif Khalifa, Ousmane Seck, and Elwin Tobing found that the wealth effect is insignificant for household income levels below $130,000 per year. For households making more than $130,000 per year, the positive wealth effect was only $0.004. This means that every dollar increase in wealth could boost consumption by less than half a penny.
