U.S. Policy Mix And The Unavoidable QE3

by: Evariste Lefeuvre

Rather than being jobless, this recovery has been slow. A possible explanation for this is the markup behavior of US businesses. The tepid recovery of 2009 can also be explained by sluggish residential investment.

The related question is the role played by the policy-mix that is the combination of monetary and fiscal policy, in alleviating the economic pain. A lot has been written on who had the best or the worst track record in terms of job creation or public spending. The charts below need no explanation.

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Yet, the ability and power of an administration to create jobs remains limited (and questionable). In addition, the recent fall in public jobs is a reflection of the financial difficulties of state and local governments, not of any federal government policy.

The chart below shows that the contribution to growth of government spending. The "cliff," as we wrote last week, is already here, since the contribution is negative at the local and federal level. A gloomier picture would come out if I took purchases and not spending as a lot of the later is made out of transfers to local governments.

I present below an assessment of the US policy mix.

The cyclically-adjusted federal spending is gauged by the residual of an econometric estimate of total government spending as a share of GDP with the output gap as an explanatory variable. The fiscal policy is clearly contractionary.

The US monetary policy stance is assessed through the MBA repurchase index, as this is part of the Fed's goal. Coupled with the current level of real interest rates, it highlights the expansionary stance of the Fed.

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The lack of leeway on the fiscal stance - at most neutral - calls for a QE3, (whatever it may look like) otherwise the US policy mix will become strongly contractionary next year.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.