In: Blog16 Sep 2012
by Andrea Terzi
What’s the logic behind Ben Bernanke’s last announcement of more Quantitative Easing (QE)?
The Fed sees QE as having effects on the price of assets (real property and stocks) so households feel richer and spend more, thus creating jobs.
Let’s explore more carefully the logic of this transmission mechanism.
One problem is that aggregate demand depends on private sector’s net financial assets, and these can only be raised by more net exports and more government net spending, not by rising prices of property and stocks.
Sure, we all agree that the price of property and stocks affects individual households. And yes, they may decide to spend more if the rise in prices of property and stocks lowers their desired net financial savings.
This all boils down to the following:
The Fed is hoping that with higher stocks and housing prices, households will be willing to increase their financial leverage, or financial obligations ratio (debt payments to disposable income).
And the Fed has no better option: If fiscal policy does not get more expansionary (such as with a full FICA suspension), all the Fed can do is to encourage households to increase their leverage.