QE3 is an unprecedented experiment that might help jump-start the economy. But it could also hurt retirees, distort financial markets, and make your groceries more expensive.
Don't ask me why but, since the Federal Reserve's dramatic policy announcement a couple of weeks ago, I have gotten repeatedly stopped -- in airports, in the grocery store, and on the street -- by people wondering what the Fed decision means for them. The answer is: it's a mixed bag
Those of you with financial assets are generally better off for now, having benefited from an immediate boost to your portfolios (including retirement accounts). Beyond this, however, the outlook is much more uncertain.
In announcing a further round of security purchases, the Fed is trying to engineer a delicate and complex policy sequence that runs something like this:
It buys securities in the marketplace in order to both lower mortgage rates and take an even bigger stock of "safe assets" out of the hands of investors. This should encourage us not only to buy houses, but also equities and other risky long-term financial assets.
Also, as asset prices go higher, we should all feel "wealthier" and have our "animal spirits" ignited. In turn, this would encourage consumption and investment spending ... and all this helps stimulate higher growth, more job creation, and less financial fragility.
Financial markets come early in this causation chain; and they are a critical element of the transmission mechanism that the Fed is pursuing.
No wonder the price of virtually every asset class rose following the policy announcement. In the U.S. stock market alone, the Fed helped engineer that day a $400 billion burst of "wealth" gains. The valuation surge is even larger when you include international equities, commodities, and corporate bonds.
This is not the first time that financial investors benefited from the Fed's actions. Since the 2008 global financial crisis, the central bank has aggressively used its balance sheet at least three times explicitly to boost asset prices. And, at least on paper, this round -- or "QE3" -- is even more powerful than the previous ones.
It is open ended. It is focused for now on just the mortgage market. And it is accompanied by a commitment by the Fed to maintain its foot on the policy accelerator well into the process of economic recovery.
But wait -- the Fed is not in the business of making investors happy. Its mandate is to maximize employment and maintain price stability for society as a whole. So, how likely is it that the financial sector's good fortune, prompted by the Fed, will end up providing the means to meet this dual objective?
This is where there are legitimate questions and concerns, and not only on account of the outlook for the next five years but also well beyond.
The Fed's hyper-activism, including venturing much deeper into experimental and unfamiliar territory, is neither cost free nor riskless. It critically depends on securing immediate broad-based benefits that overcome our economic malaise and change the momentum of the economy. Otherwise, it is very difficult to justify the real and present danger of collateral damage and unintended consequences.