Quantitative Easing Revisited

The recent spate of negative economic news is motivating downward adjustments in the near-term growth outlook for the US economy, both in the private sector and amongst policymakers. In contrast with the positive revisions that followed the extension of tax cuts and expectations that higher net incomes would give the economy a bump in early 2011, the most current data show that the expansion slowed in the first quarter. The Bureau of Economic Analysis’ revised estimate, released on May 26, shows real annualized growth of 1.8 percent in Q1’11, down from 3.1 percent in Q4’10 (see my May 2 analysis of the preliminary report, Economic Recovery Slows in First Quarter). Consensus forecasts put GDP growth for 2011 at 2.6 percent, consistent with only modest improvements in the pace of payroll gains through the end of the year.

Concerns about the lackluster pace of the domestic recovery and spillovers from disruptions to growth in Japan, the Euro Zone, and the Middle East, coincide with the planned conclusion of the Federal Reserve’s second quantitative easing (QE2) program this month. As a result, questions about the efficacy of this unorthodox policy intervention are receiving new attention. Should we extend the Fed’s purchases of Treasury securities? And if so, what are the attendant risks of growing the central bank’s balance sheet even further?