While the Federal Reserve is focused on core consumer prices and unemployment, AllianceBernstein believes the Fed is not adequately monitoring the cumulative effect that quantitative easing is having on financial asset prices directly and on real asset prices indirectly.
AllianceBernstein US economist and director Joseph Carson said quantitative easing has led to an asset price-driven balance sheet cycle.
“The cumulative effects of asset price gains are most evident in the US household balance-sheet cycle, as gains in relation to income growth have matched the strong ones recorded during the equity cycle in the late 1990s and the real estate cycle of the early to mid-2000s,” said Mr Carson.
Mr Carson said at the end of 2013 the ratio of household net worth to disposable income stood at 639 per cent.
He said this is above the peak reading of 615 per cent during the late 1990s equity boom, and close to the 659 per cent reading at the housing boom’s peak in early 2007.
Unlike the equity bubble of the 1990s, however, which saw excessive leverage on business balance sheets, and the mid-2000s housing bubble where the household sector took on record amounts of debt, the current cycle has seen the Federal Reserve take on high levels of debt.
Mr Carson said the Federal Reserve has increased its debt levels to $3 trillion since March 2009.
“And the expansion of the Fed’s balance sheet is not over yet,” he said.
“Even if it follows its current script of winding down the asset purchase program by $10 billion at each regularly scheduled Federal Open Market Committee meeting, the Fed will still add another $300 to $350 billion to its balance sheet by the end of this year.”
Policymakers, however, remain reasonably relaxed about the pace of tapering, said Mr Carson, because they are using the unemployment rate and narrow core consumer price measure as a guide.
“While the core consumer price measure continues to hover below the Fed’s target of two per cent, it’s worth noting that it failed to be a reliable gauge for policymakers in each of the past two cycles,” said Mr Carson.
“It did not capture the price misalignments in the asset markets that ultimately caused major macroeconomic imbalances.”
Mr Carson said the Federal Reserve’s focus on consumer inflation is so excessive it is continually revising policy goals and objectives.
He explained, for example, that the Fed initiated ‘QE3’ to encourage a substantial improvement in labour markets and to reduce the jobless rate down to seven per cent.
However, Mr Carson said when the Fed did actually begin to taper, the jobless rate had already declined to seven per cent.
He also said policymakers are backtracking on their original plan for normalising the Fed funds rate.
“Until early 2013, policymakers had consistently stated that the exceptionally low Fed funds rate would remain in place as long as the civilian unemployment rate remained above 6.5 per cent,” said Mr Carson.
“Now, the official script indicates that policymakers plan to keep the official rate 'well past the time the unemployment rate declines below 6.5 per cent'.”
Mr Carson said policymakers need to define what their ultimate goals are and what direction they want to go in.
“In the process of trying to secure even bigger gains on the jobs front, they could be creating other imbalances along the way that could backfire later,” he said.
