After proponents of the Federal Reserve’s second round of quantitative easing (QE2) abandoned the argument that QE2 would spur growth by bringing down interest rates (only after rates increased), the new defense became “we intended for rates to go up all along, as a result of increased inflation expectations.” Since few would argue for increased inflation, or expectations of such, as an end in itself, the claim was that increases in inflation expectations would drive households to consume more, which would in turn causes businesses to hire more, bringing down the unemployment rate. But does this chain of reasoning withstand empirical scrutiny?
It turns out looking at the historical data on inflation expectations, as collected at the University of Michigan, that inflation expectations and household savings rates (the inverse of consumption rates) are positively correlated. Now of course correlation doesn’t mean causality,but what the data suggest is that instead of consuming more when inflation expectations increase, households have actually saved more. This positive correlation also holds for the second half of the data series, so it’s not simply the result of a downward trend in either inflation or savings.
To review, the latest argument for QE2: increase inflation expectations, which is assumed to increase consumption, which is hoped to increase employment. The problem I’ve had all along with this position is that the only thing we know for certain is the first part, QE2 would increase inflation expectations. The hope that it would increase consumption and hence employment was just that: hope. Given the disconnect we’ve seen between consumption and unemployment over the past 18 months, the third link in that chain is also a weak one. So what do we have at the end of the day: certain costs with fairly speculative and uncertain benefits. And here I was thinking that reckless speculation was the sole province of the private sector.