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Banks need their own stimulus to start lending

The Fed has already spent $1.8tn trying to entice banks to start lending again to small businesses and consumers. Will another $8bn make any difference?

The Fed has already spent $1.8 trillion trying to entice banks to start lending again to small businesses and consumers. Will another $600 billion make a difference?

Ben Bernanke, the US Federal Reserve chairman, has been getting a lot of flak of late for embarking on another round of treasury bond buybacks in an effort to stop the country's low inflation rate from dropping and its high unemployment rate from rising.

He has been attacked by foreign governments around the world, including China, Germany and Russia, who view this as an effort to manipulate the value of the dollar downwards and give the US an unfair advantage in export markets.

He has been attacked in a cartoon video on Youtube called Quantitative Easing Explained, which claims that quantitative easing is a Fed euphemism for printing money to cure the country's woes, and has already attracted 3.1 million views.

He has even been attacked by the world-renowned Fed-watcher Sarah Palin, who said last month she was concerned about what she characterised as Mr Bernanke's plan to start "printing money out of thin air" and that it was far from certain to work.

Of course, there are those who argue he has no choice but to act. Depending on who you listen to, the legacy of this latest US$600 million (Dh2.2 billion) round of purchases between now and June that the Fed announced last month is either going to be a rapid spike in asset prices, a weak dollar and runaway inflation in the US, or the end of what would otherwise be a lengthy period of US deflation. With any luck, the policy will succeed in creating a modest increase in inflation.

Over the past 12 months to the end of October, the Consumer Price Index for all items less food and energy has risen 0.6 per cent, the smallest year-on-year increase since the index began in 1957. The official inflation rate is now 1.2 per cent and the Fed would like to see long-term inflation a bit higher, somewhere between 1.7 per cent and 2 per cent, in order to achieve job growth and keep prices stable.

But, in a speech in New York last week, Jeffrey Lacker, the president of the Federal Reserve Bank of Richmond, rejected the idea that quantitative easing would lead to a surge in inflation.

He said some of the opposition amounted to "hysteria" and argued the Fed would begin to withdraw monetary stimulus when the time was right, to avoid that risk.

In fact, he said it was committed to reviewing the existing program every month until it ended in June to see if it was still needed.

However, Mrs Palin may be right on one critical point - quantitative easing hardly has a stellar track record when it comes to stimulating job creation, an important goal when the official US unemployment rate is still just shy of 10 per cent.

The Federal Reserve has already spent $1.8 trillion on quantitative easing since November 2008, buying treasury bonds from the banks in exchange for money in two failed attempts to get them to start lending to small businesses and consumers.

As a result, bank depository institutions are currently sitting on about $986bn in reserves, according to the Federal Reserve, yet that has still not encouraged them to start lending again in the sort of volume necessary to create economic growth.

If $1.8tn of new cash was not enough to spur banks into action, giving them access to a further $600bn in cash is unlikely to succeed either. If nothing changes, banks will just continue to hoard an even larger stockpile of cash than they did before.

Of course, in the unlikely event that banks do have a change of heart and start making a huge amount of loans to businesses and consumers against this depositary reserve mountain, it could get very difficult for the Fed to keep control of inflation, no matter how much it says that it is ready for that scenario.

For now, though, for all the furore about the Federal Reserve's latest monetary stimulus, it essentially is a drop in the ocean.

Published: December 12, 2010 04:00 AM


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