Yesterday, a reader asked why I thought QE3 wouldn't do much to spur the economy (specifically consumer demand). I answered that investors would lift prices on commodities (as they move to protect themselves from prospective inflation), which would ultimately raise prices on consumers, who can't react as quickly as investors can from changes in monetary policy. I want to expand upon that, because he also brought up a concept called GDP (output) gap, and it's something that really bothers me.
GDP gap is the difference between actual output (what we produce in a given amount of time) and what we can potentially produce in that same time frame. In normal times,GDP growth is considered synonymous with capital/wealth growth because there is no perceived gap in actual GDP and potential GDP. After a recession (when output contracts), immediate GDP growth is considered "catching up" to what we were previously making. Once we bridge the gap, any new growth is assumed to be more wealth creation.
The only problem is GDP gap is a terrible concept. It can't be accurately measured. Even in the best of times, there is still a theoretical GDP gap because, collectively, we could all work more hours or a greater percentage of the population could be working or both. The gap is measured by taking labor metrics (workforce participation, labor utilization, average hours worked) from a time that is considered healthy and comparing it to a time when the economy is considered to be performing poorly.
People can always work more hours. More people can join the workforce. There is always more work to be done. When you consider it from that standpoint, output gap is essentially meaningless because it doesn't measure anything that we didn't already measure before.
So how does that relate to the current state of affairs? Back in 2008, GDP stood somewhere around the range of 14.4 trillion dollars. By the end of this year, it will be around 15.6. The reason why some economists still consider our economy to be in the midst of a GDP gap is because all that growth in GDP occurred during a time when employers were slashing payrolls and making the remaining employees work harder for longer periods of time.
In other words, we increased GDP by increasing productivity faster than we decreased employment. The thinking is that we'll get back to the good times when everybody rejoins the work force at a level before September 2008 while keeping as much of the productivity gains as possible.
Other economists say "hold up a second, the labor statistics we see now seem to indicate that this is the new normal". Which is to say we can't go back to the employment and productivity numbers we saw in early 2008 (or, for that matter, 1999) because the economy has been altered permanently in some way. The old cliche rears its ugly head: the truth probably lies somewhere in between.
The reason why I say looser monetary policy (QE3) won't get us closer to 2008 is because monetary policy isn't the right tool to tackle the problems that our economy is facing. The three most consequential phenomena that occurred between 1980 and now are the diverging real savings rates between the top 10% of households and the rest of society, increasing socioeconomic stratification among emerging adults (teenagers who are past high school and twenty somethings), and the yawning gap between what most kids learn in secondary education (essentially nothing) and what is required in the modern workplace (which is actually a lot different from what you probably think it is).
Fiddling with the money supply isn't going to change any of those factors except exacerbate the first one. When the Federal Reserve buys Treasurys (real word, honest) and injects money into the financial system, the first group to be affected by it are the primary dealers (aka the large banks who make the Treasury market). The second group that it affects are the participants in the secondary Treasury market (funds of all various colors and large non-financial companies). Everybody else (small businesses and employees) feel the effects downstream, when it's too late for them to take any meaningful action.
If we've learned anything in the past, it's that Wall Street will make its money whether interest rates are low or high. They pay much more attention to monetary policy. It's their job. Everybody else learns what happened the next time they go take out a loan or fill up their car. And that's why I think QE3's effect on the broader economy is going to be minimal, at best.
Bernanke has admitted as much. But the reason why he feels compelled to act is because the Federal government won't. Policy making essentially grinds to a halt during the campaign season. And there is a lot of economic uncertainty looming (1 year away from the full implementation of the PPACA with the rules yet to be fully determined, the tax rate resets, sequestration) that is a direct result of both Congress and the President's unwillingness to act.