For the sake of argument, let us assume that in the next seven months combined Federal Reserve and commercial banking system credit increase a net $600 billion, the amount of the Fed’s planned securities purchases over this period. This would represent a 5.2% increase in the September level of combined Federal Reserve and commercial banking system credit. Chart 7 shows that there has not been a seven-month increase in this credit aggregate of 5.2% or greater since March 2009. Now, a 5.2% increase in combined Federal Reserve and commercial banking system credit is unlikely to result in a boom in nominal aggregate demand, but it will help prevent the economy from slipping back into a recession within the next 12 months in the face of substantial economic headwinds emanating from the housing and state/local government sectors of the U.S. economy.
There appears to be some concern by foreign monetary authorities that QE2 will result in the Federal Reserve “exporting” some U.S. inflation to their economies. This could occur if foreign central banks peg their currencies to the U.S. dollar. If QE2 puts downward pressure on the foreign-exchange value of the dollar and foreign central banks purchase dollars in the open market in order to prevent an appreciation in their home-country currencies, paying for these dollars by issuing their own currencies, then, indeed, foreign central banks could be “importing” increased inflation. But foreign central banks are not obligated to do this. They could accept an appreciation in their currencies vs. the dollar. Would this have an adverse effect on exports to the U.S. of economies whose currencies are appreciating? At the margin it would. But overall exports to the U.S. from these economies might remain the same or even increase as the negative foreign-exchange effect, or price effect, might be more than offset by the “income” effect in the U.S. emanating from QE2. That is, QE2 would be expected to increase the nominal demand for goods and services, some of which would be imported goods and services.
We have not published an economic/interest rate forecast update since August due to no meaningful change in our outlook and due to an extremely heavy travel schedule. We apologize for this “silence” to any clients and partners who missed our updates. Since our August publication, we have reduced marginally our 2011 real GDP growth forecast from 3.2% on a Q4/Q4 basis to 3.0%. The reduction is primarily due to a reduction in our 2011 growth forecasts in the categories of residential investment expenditures and state/local government spending. Despite the downward adjustments to these categories, we believe that stronger real GDP growth can be achieved in 2011 compared with 2010 and some modest reduction in the unemployment rate can occur in 2011 with the small but positive growth in commercial bank credit that we anticipate and the increase in Federal Reserve credit as a result of QE2. We also have pushed back into early 2012 our forecast of the first Federal Reserve interest rate increase. Even if QE2 were to end in the second quarter of 2011, and there is no guarantee that it will end at this time, the FOMC is unlikely to begin raising its policy interest rates – the federal funds rate and the interest rate it pays on banks’ excess reserves – immediately after the end of QE2.
Paul L. Kasriel
Asha G. Bangalore
The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.
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