A client writes, “You mentioned in your latest commentary that deflation would rear its ugly head if QE were limited. Do you think QE is the solution to keeping the stock market inflated and also the economy? I fear that QE isn’t the solution – maybe for the stock market – but not for Main Street.”
It’s doubtful that the Fed’s quantitative easing (QE) policy can heal the wounds inflicted upon the economy by the 2007-2008 credit crisis. This may not have even been Bernanke’s intention when QE was initiated back in 2008. The principle reason for QE was to provide the banking system with needed liquidity and to also satisfy the world’s insatiable demand for money. In that regard QE was a success.
QE was mildly helpful in stimulating business activity via the trickle-down effect, though it has far from reinvigorated the economy. More than anything, QE has help to keep deflation at bay by allowing the financial system to stabilize and recover after the devastation of the credit crash. The financial sector is the lifeblood of the economy and as long as it has abundant cheap liquidity at its disposal, businesses have no imminent fear of falling profits/prices.
The coming end of QE changes this equation. The economy will be forced to reckon with the “hard down” deflationary forces of the 120-year cycle next year without the aid of central bank stimulus. It would be surprising to say the least if the financial market and the economy can weather this storm without QE’s assistance.
You are correct that QE isn't the answer for Main Street (though it has certainly helped somewhat). IMO, the Fed should consider letting QE continue until at least the end of 2014 when the cycle bottoms; after all, why stop now when they've kept it going for five years? The Fed could then let the economy finish the healing process on its own when a new long-term inflationary cycle begins in 2015.