Edward Deak: QE2 Effect on Jobs Temporary and Minimal

by: Harlan Levy

Edward Deak is a Fairfield University economics professor, formerly head of the department. He is also the Connecticut model manager for the New England Economic Partnership, which produces a semi-annual New England forecast, next due Nov. 17.

H.L.: What will be the effect on the U.S. economy of the mid-term election and the Republicans’ plans for drastically cutting spending and repealing healthcare reform and financial regulations?

E.D.: The more conservative Congress will be listening to the voters, rightly or wrongly, who don’t understand the severity of the problem we’re facing. Justifiably, they are extremely worried about the direction of the country. I think the Republicans are going to try and rein in the spending, and I think the Bush tax cuts will be extended.

The lame-duck session of Congress will be full of issues needing attention. First is the tax cuts. If they don’t extend them, you’re looking at a tax hike for over 100 million people starting in January for all of 2011.

The extension of unemployment benefits for about 2 ½ million people is next. They’re going to run out at the end of December.

Thirdly, they have to deal with the alternative minimum tax. The exemptions are going to end at the end of the year, so they have to deal with them, or 25 million more people will have to pay more taxes.

If that’s not enough, the federal government doesn’t have a budget and is operating under a "continuing resolution" which runs out at the end of the year. If you don’t extend it, the federal government closes its doors Jan. 1.

That would be enough economic work for a full session, forget about a lame-duck session, and how much they get done is open to question, because the Democrats can’t agree among themselves, and they certainly can’t agree with the Republicans.

Also, the president’s deficit commission is due to present its report Dec. 1, and that will add fuel to the fire.

We’d better extend at least some of these tax cuts, benefits, and exemptions, or it’s going to reduce paychecks in January. People can’t spend money they don’t have, and there will be less growth, fewer jobs, and more dissatisfaction with government.

H.L.: Will the Federal Reserve’s QE2 buying of $600 billion worth of Treasurys do more than temporarily lift the stock market?

E.D.: The anticipation of QE2 certainly had a positive effect on the stock market and on lowering long-term interest rates. While the Fed is doing this, you can look for lower interest rates, higher stock prices, and a lower exchange value for the dollar, which should help U.S. exports.

But I’m very concerned that the employment effects will most likely be temporary and minimal, because you’re dealing with markets that are in the trillions of dollars, and you’re only injecting about $100 billion a month.

The real problem is in the intermediate term as you go out 12 to 36 months. You run the risk of inflationary pressure, the bursting of a bond market bubble, foreign competitive currency devaluations — that is, getting into a trade war — and you run the risk of undermining the Fed’s credibility and independence. The Fed is likely to be taken to task by much more conservative, newly elected Congressional representatives.

H.L.: Friday’s private-sector job gains buoyed the economy a bit, but will they continue, and when do you see them returning to pre-recession levels?

E.D.: The more than 150,000 job gains in October was a very welcome, long-overdue number. How long that pace can last, or even better numbers appear, depends on the short-term success of the Fed’s quantitative easing program and Congressional restraint on cutting federal spending. If they cut the heart out of the federal budget that will not be supportive of short-term job growth. Less job growth keeps the unemployment rate up and keeps a lot of people on the economic margin.

H.L.: What's your take on the housing market and the foreclosure crisis?

E.D.: This is a problem that’s going to persist into 2011. Prices are going to weaken further, putting more homeowners under water, relative to their mortgages, and if job growth doesn’t at least maintain its October pace, there will be more foreclosures and distressed sales in 2011 and 2012.

H.L.: What’s your prediction for the U.S. economy in 2011, 2012, and 2013?

E.D.: 2011 could be a difficult transition year. If monetary easing by the Fed works and it is supported by federal spending, by the end of 2011 and the beginning of 2012, the U.S. economy may be able to sustain a reasonable expansion. As you go into 2013 and 2014, inflationary pressures should build, and towards the middle of that decade you may find yourself facing another economic turning point. I don’t want to use the word "crisis," but you could be looking at that kind of situation, because the Fed will have to raise rates, and the government will have to deal with the deficit. And they’ll still have to deal with the gorillas in the room: Social Security, Medicare, and Medicaid. They’ve never left the room.

H.L.: What’s ahead for stocks?

E.D.: In the near term, the market will do very nicely. You’re probably looking at 12,000-plus for the Dow Jones Industrial Average in 2011. Then the question is how will the presidential year of 2012 play out. If the campaign is as negative and unproductive as the one in 2010, it could risk dampening business and consumer confidence and spending in 2012.

H.L.: How's Connecticut doing?

E.D.: Connecticut faces two problems: One, we have a massive budget deficit and debt problem, and two, the Connecticut recovery is likely to lag and be slower than whatever happens at the national level. We have our own problems in terms of growth, competitiveness, budget deficits, and debt that have some unique characteristics. apart from what’s happening nationally.

Disclosure: No positions