QE Blew

The most recent GDP numbers were dismal.  The Q1 2011 growth rate was revised downwards from an anemic 1.9 percent to a virtually invisible .4 percent.  Q2 growth was a measly 1.3 percent.

This creeping growth coincided with the Fed’s most recent “quantitative easing” episode–QE2.  QE2 was predicated on a variant of Phillips Curve reasoning.  Bernanke and the Fed were concerned that the economy was lurching into a deflationary episode, and wanted to “re-anchor” inflationary expectations upwards in the belief that this would spur spending and growth.  Hence the operation to monetize huge amounts of debt.

Note that QE2 evidently had the desired effect on inflation.  The price indices for gross domestic purchases rose 4 percent in the first quarter, and 3.2 percent in the second.  Core inflation was 2.6 percent in the first quarter and 2.4 in the second–both well above the Fed’s 2 percent “tolerance” zone.

One very reasonable interpretation of all this is that the Phillips Curve is bunk: there is no tradeoff between inflation and growth.  Like we didn’t know that before.

But no tradeoff doesn’t explain the paltry growth, especially at this phase of the alleged recovery.  One highly plausible explanation is that the combination of regulatory onslaught and a burgeoning debt overhang is a drag on the economy.

If there is in fact a Phillips curve, that would mean that the drag resulting from the metastasizing Federal government is even bigger.

These figures are consistent with an incipient stagflation.  Great news.

The economic performance is definitely not great news for Obama’s re-election prospects.  Hence the palpable desperation in the attempts of the administration and its acolytes (including vast swathes of the media) to put the blame somewhere else, anywhere else.  Some of these efforts are same old-same old Blame Bush, or the Japanese earthquake, or the weather.  Seriously.  But some of the efforts are truly novel, and involve violations of the laws of nature.  Specifically, some have endeavored to pin the economy’s somnolent performance in January to June on Republican intransigence on the debt ceiling in July.

Quite a trick.  Note to class: cause must proceed effect.

But there is a link between the economy’s stall and the dynamics of the debt ceiling debate.  The stall is politically fraught for Obama and the Democrats in November, 2012.  There is likely nothing that they can do to rejuvenate the economy in the next 15 months.  Indeed, with this lot, anything they’re likely to try would make things worse.  So not being able to change the substance, the only alternative is to shift the blame.  And precipitating a crisis over the debt ceiling is one way of throwing a lot of dirt in the air, changing the subject, and creating an alternative narrative with a different villain.

It’s a high risk strategy, but desperate times call for desperate measures.  And based on objective measures–including plummeting popularity and foreign policy fiascoes as well as a sick economy–Obama’s situation is desperate.

Which all bodes ill for compromise, the New Civility–and the economy.

About Craig Pirrong 223 Articles

Affiliation: University of Houston

Dr Pirrong is Professor of Finance, and Energy Markets Director for the Global Energy Management Institute at the Bauer College of Business of the University of Houston. He was previously Watson Family Professor of Commodity and Financial Risk Management at Oklahoma State University, and a faculty member at the University of Michigan, the University of Chicago, and Washington University.

Professor Pirrong's research focuses on the organization of financial exchanges, derivatives clearing, competition between exchanges, commodity markets, derivatives market manipulation, the relation between market fundamentals and commodity price dynamics, and the implications of this relation for the pricing of commodity derivatives. He has published 30 articles in professional publications, is the author of three books, and has consulted widely, primarily on commodity and market manipulation-related issues.

He holds a Ph.D. in business economics from the University of Chicago.

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