There's more and more talk about the monetary policy of the Federal Reserve. Headlines pop out at us, like "Fed Stimulus Likely in 2013", with the subheading, "Bond Buying Is Expected to Continue in Effort to Spur Slow-Growing Economy."
Certainly, real economic growth needs to improve if the unemployment rate is to fall.
The question is, how much can monetary policy do to achieve greater economic growth? After more than four years of the most expansive monetary policy in United States history, economic growth is still quite mild.
The revised economic growth figures were released Thursday, and the good news is that the revision was upwards to 2.7 percent for the quarter. This represented a massive revision upwards from 2.0 percent.
Year-over-year, the improvement was not as large, but year-over-year, the economy is growing by 2.5 percent.
The bad news about the revision is that the major reason for the improved growth rate was a rise in inventories and a reduction in the trade deficit, items that may not stick around for long.
In the initial estimate, inventories seemed to be growing at a 0.12 percent rate for the quarter. The revised number indicates that inventories are rising at a 0.77 percent rate. So almost all of the revision in the growth rate of real GDP came in a buildup in inventories.
"Stuff" did not get sold!
And, as a consequence, businesses are expected to cut back on production in the fourth quarter to reduce inventories to a more prudent level. Interpreting the fourth quarter figures will be somewhat difficult, given that they will be impacted by the results of Hurricane Sandy.
However, the early estimates by economists for fourth quarter real GDP growth are substantially lower than the revised third quarter results, coming in somewhere in the 1.2-1.5 percent range.
This means that the annual growth rate for real GDP in 2012 will probably be in the 2.0-2.2 percent range. Pretty tepid!
As far as prospects for future sustainable growth, the numbers do not produce a lot of encouragement. Let's look at real investment expenditures for a minute.
Real private nonresidential investment has been declining this year from a growth rate or 12.5 percent in the first quarter to 9.7 percent in the second quarter to 4.5 percent in the third quarter. Real private nonresidential investment is not expected to pick up much in the upcoming quarters. Large corporations don't seem to have a lot of confidence in the future, and appear to be more interested in paying out special dividends or engaging in stock buybacks than in investing in plant and equipment. This does not bode well for a pickup in business investment.
Small business confidence also seems to be waning.
Real private residential investment has picked up this year. In the first quarter, its year-over-year rate of growth was 9.3 percent. The growth rate rose in the second quarter to 10.4 percent, and then rose again in the fourth quarter to 13.7 percent.
The good news is that the housing market seems to be improving. The not-so-good news is that the improvement was at an extremely low level relative to recent history. Even with the improvement in the third quarter of 2012, real private residential investment is 52.5 percent below its peak level of 783.5 billion reached in the third quarter of 2005. The following chart shows this relationship:
So housing is picking up, but it is a long way from really providing a steady base for economic expansion.
Furthermore, the consumer has not really been spending. The year-over-year rate of growth for real consumption expenditures, more than 70 of real GDP, was 1.8 percent for the third quarter of 2012, and has been at this level for the past year. Consumption spending is not taking off!
So given all of the efforts of the Federal Reserve System -- the extraordinarily low interest rates and all -- the real economy is just not showing much life.
The Federal Reserve stopped the solvency crisis and has provided sufficient liquidity to the financial markets, so that they are functioning well. This activity helped to reverse the financial crisis. But the Fed's actions are doing very little to "goose up" economic growth.
Should we be surprised by this result? I don't think so. I thought the reading of history indicated that over the longer term, monetary policy impacted only nominal values and not real values. Real values, like economic growth, were impacted by real variables, like productivity and real capital investment and the growth of the effective labor force. Real growth rates were impacted by the structure of the economy and the advancement of physical capital and human capital.
Monetary policy only influenced real economic performance in the short-run, and the impact of monetary policy only came from monetary "shocks" to the economic system that arose from a short-term absence of liquidity somewhere in the financial markets.
To me, the slow economic growth is due to the fact that the economy needs restructuring. Our under-employment is too high. I place under-employment at around one individual out of five of working age people. Many skills are out of date, and workers do not necessarily live where the work is. Manufacturing capacity is not be used in large amounts due to non-competitive plant and equipment. We need new kinds of capital, and we need it in new locations. Monetary policy is not going to have much of an impact on these things.
The Federal Reserve is trying to handle a situation that is not covered in economic textbooks. They are learning by doing. However, I think it would help them if they were not so myopic, focusing on just the short run. They need to appreciate the fact that maybe the economy needs to do some restructuring in order to achieve faster, more sustainable economic growth.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.