On November 2, former Bank of England policy maker Charles Goodhart gave an interview in which he declared that quantitative easing is a "spent force" and that the Bank of England is not doing enough to stimulate lending. If this is the case, then Goodhart's critique of the BOE is even more true for the Fed.
Before explaining how the Fed has failed on this front, I should note that the Goodhart was saying that quantitative easing is a spent force in Britain, he was not specifically talking about the U.S. One could argue that since the BOE engaged in more aggressive QE (per capita) than the Fed during the crisis, that it is more spent in Britain than in the U.S. Regardless of whether this is the case, the BOE has also engaged in measures directly aimed at stimulating lending, while the Fed has been loath to do the same.
In particular, the BOE initiated its "Funding for Lending" scheme in spring of 2012. The scheme basically boosts bank lending to non-financial businesses and households by lowering the cost of funding and increasing access to credit for banks that engage in this lending. This complex, quasi-fiscal policy is targeted at increasing the velocity of money in private hands rather than simply increasing the cash holdings of businesses. In his June press conference, Fed Chairman Bernanke indicated that the Fed was keeping a close eye on this program, but the Chairman was obviously not impressed enough to try a comparable program in the U.S.
By September, the press was declaring Funding for Lending ineffective and Bernanke appeared right to avoid a program to induce lending. However, the recent data has proven quite the opposite, lending throughout Britain has risen sharply this fall and Funding for Lending is rapidly growing. Nevertheless, Dr. Goodhart says that the BOE has not done enough to stimulate lending; he even suggests cutting the rates paid on excess bank reserves to induce lending.
So, what has the Fed done to stimulate lending? No much. In September the Fed elected to engage in a third round of asset purchases. More than a month earlier, I had written that The Fed Should Stimulate Lending, and I stand by that position. The private sector is currently sitting on trillions in cash thus depressing the velocity of money and limiting economic growth. The solution to this problem is not to simply add more capital to the system in hopes that private sector businesses, particularly banks, use growing reserves to begin lending again. Instead, as Dr. Goodhart notes, policy should promote lending. This would increase the velocity of money and decrease the need for perpetual asset purchases that will eventually increase inflationary pressure.
In short, if Dr. Goodhart believes that the BOE has not done enough to stimulate lending, it stands to reason that since the Fed has done even less, his critique is even stronger for U.S. monetary policy makers. Assuming Dr. Goodhart is correct and that the Fed remains on its current path, our recovery will continue to sputter along while the Fed keeps injecting more capital for businesses to hoard. However, it is entirely possible that given the growing success of Funding for Lending, the Fed may attempt a comparable program in the U.S. If the Fed does so, it will likely occur at the beginning of 2013, immediately after Twist expires. Such a program could rapidly benefit the housing sector along with other businesses reliant on freely available capital for small borrowers.
Investors should keep an eye on the Fed's potential plans to stimulate lending. If they eventually follow the BOE's lead and Dr. Goodhart's advice, we could see robust growth in the housing sector and even a resurgence of the collateralized debt market. This would increase the velocity of money in the system and free up capital for household and small business borrowers, thereby increasing consumption of big ticket items and rapidly aiding the real estate market and auto industry.