Why QE3? Fed Right to Focus on Other Things

NEW YORK (TheStreet) -- Post-Jackson Hole and Federal Reserve Chairman Ben Bernanke's speech there, attention has shifted to this month's Federal Open Market Committee and the debate over QE3 -- a third round of so-called quantitative easing.

Given the weakness of the recovery, volatile financial markets and the headwinds from fiscal austerity, why wouldn't the Fed engage in another round of easing? After all, QE2 was initiated last year when the recovery and global financial markets were less fragile.

The Federal Reserve is considering a third round of quantitative easing.

QE3 is not a done deal and could prove to be ineffective despite the current economic weakness. More and more, monetary policy (especially quantitative easing) appears ill-equipped to provide support for the fragile recovery.

Consider these factors:

• QE2 remains controversial, and its timing was better: It is always difficult to isolate cause and effect in an environment as tumultuous as this global economy, so QE2 remains controversial. Unlike the first set of actions the Fed took in 2007 and 2008 to stabilize the global financial system, the impact of QE2 is more muddled. Clearly, the dollar depreciated, equity markets improved and inflationary expectations (and retail price movements) increased. It is also clear that economic activity did not accelerate, commodity prices increased further and overseas central banks had to respond to the Fed's actions. In today's environment, retail price pressures are more prevalent (and not deflation), the dollar is already weak and interest rates are at modern lows. From the standpoint of interest rates, Fed statements over the past few weeks have accomplished what QE3 would do, namely bring down rates. So what else QE3 would accomplish (besides a temporary bump in equity prices) is something that is not clear at this juncture.
• The Fed still has options, but ... : The Fed's actions since the beginning of the crisis have been unprecedented, including aggressive rate cuts, asset purchases totaling almost $3 trillion and a willingness to provide liquidity to financial and nonfinancial institutions. Yet there comes a point where monetary policy is pushing on a string, and the Fed is probably past that point. Liquidity is no longer an issue. Financial institutional balance sheets have improved considerably and households have begun the long journey of rebuilding balance sheets. In addition, remaining committed to its current accommodative stance through 2013 is a bold action in support of the recovery. Maybe the time has come to stay on the sidelines for a time and let other policy solutions support the recovery?
• Fiscal policy in the U.S. and Europe matters more than the Fed: Support for the recovery is not a monetary policy issue. The focus should be on fiscal policy and the need to provide support in the short term and a credible plan to address debt levels over the intermediate to long term. One concern with the Fed repeatedly intervening is to shift the focus away from where the policy issue sits -- namely in Washington and European capitals. Enhanced confidence levels stemming from stronger fiscal policy would have a more substantial impact on the recovery than QE3 or any other measures the Fed can bring forward.

QE3 may not be a done deal at this point, and if it does not come to pass, it will certainly not be the end of the world.

And perhaps the focus will shift to where it should be: the next round of fiscal negotiations.

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