Stock Plunge Likely Remedy to Fix Fed’s Failures: AEI’s Makin

As the Federal Reserve is set to end its quantitative easing bond-buying program this week, a veteran Fed watcher is warning the U.S. central bank increasingly demonstrates it has no answers to today’s economic challenges, leaving a severe market sell-off as the sole means of righting the economy.

The Federal Open Market Committee (FOMC) is set to formally conclude its $15 billion a month asset-purchase program when it meets in Washington Tuesday and Wednesday.

That meeting comes on the heels of another economic gathering in Washington—this time by officials of the IMF and World Bank, who earlier this month “were able to agree on one important thing,” says American Enterprise Institute resident scholar John Makin: namely, that “the global economy, especially in Europe but also in Asia and the United States, is slowing again, and outright deflation is drawing ever closer.” Makin has long warned about the risk of deflation, which he sees as the key global economic threat.

Now writing ahead of the FOMC meeting, Makin notes that the anticipated withdrawal of stimulus would occur at a time of increased market volatility which he believes has Fed officials scared, with spillover effects in a private economy that is increasingly losing confidence in policymakers.

“The Fed’s rising nervousness has been illustrated by a tendency toward rapidly shifting views among Fed leadership,” writes Makin in the monetary policy analysis.

“Fed Vice Chairman Stanley Fischer went from an Oct. 9 assessment that the Fed could begin tightening around mid-2015 — or perhaps a little earlier than the ever-shifting consensus — to an opposite, outright risk-on call on Oct. 11, saying that if the global economy continued to weaken, the Fed would further delay its move to higher rates.”

St. Louis Federal Reserve President James Bullard went further than suggesting putting tapering on hold, suggesting the possibility of a fourth round of quantitative easing (QE) in the face of a weakening global economy.

Makin laments that these comments followed a major market sell-off, despite the fact that the global economy has been declining for a half a year.

Indeed, despite shoots of growth such as occurred in the second quarter, U.S. GDP seems incapable of escaping its new normal 2% growth trend.

And that torpid pace is rapid-fire in comparison to the European economy, where outright deflation and a potential third postcrisis recession looms.

What Makin finds especially discouraging is that policymakers like European Central Bank President Mario Draghi are pushing for a European QE2 despite his view that that has already been tried and failed in the U.S., where it has not even blunted disinflation, let alone spurred growth.

Indeed, a particularly aggressive monetary stimulus program in Japan provides a particularly poignant example of the limits of easy money. There, the promise of Abenomics has fizzeled with second-quarter growth falling to a -7.1% pace.