Why the Fed Should Initiate a New Round of Quantitative Easing

To combat the economic burden of household debt, the Federal Reserve should initiate QE3: a new round of quantitative easing targeted at American debtors. 

The idea of comprehensive debt forgiveness is not new. In times of ballooning wealth inequality and economic stagnation, demands for a Jubilee, a cancellation of all debts, grow with striking poignancy. Debt forgiveness is a policy that the United States federal government engaged in during the recession with the Federal Reserve’s purchase of $2.1 trillion dollars worth of bank debt as of June of 2010. By absorbing these otherwise toxic assets, the Federal Reserve gave the banks the ability to consolidate capital and make economy saving investments. But banks were hardly the only economic agents burdened by debt. The Federal Reserve Bank of New York observed that total household debt balance nearly tripled from $4.6 trillion in 1999 to 1$2.5 trillion in 2008. Though the figure has since fallen to $11.5 trillion as of the first quarter of 2011, the number is still an impressive figure. “From 1997 to 2007,” writes the Wall Street Journal, citing Federal Reserve data, “household debt ballooned to 66 percent of economic output to 98 percent.” Seventy-four percent of the debt is from homeowners’ mortgages, and debts on student loans have likewise ballooned to nearly three times that of the home mortgage debt during the Clinton administration. 

It is important to observe a few trends. First, despite a 114 percent increase in labor productivity over the last 40 years, workers’ wages in the same time period have decreased 6 percent when adjusted for inflation. Meanwhile, the gains of labor’s productivity have been concentrated amongst the wealthiest Americans: J.P. Morgan4 explains that 75 percent of U.S. corporate profit margins since 2001 have come from depressed worker wages. The juxtaposition of repressed wages and increased access to credit brought about greater borrowing and debt. This economic problem reached a climax in 2008. Americans, now paralyzed by a fear of debt, are spending and investing less than they did during 2005. As the Wall Street Journal highlighted, “two-thirds of Americans polled online in July by U.K. research firm Absolute Strategy Research said they planned to either reduce their debt within a year or stop borrowing altogether.” The phenomenon cannot be reduced to the depletion of access to capital: this hesitation reaches even to workers with excellent credit. Now lower demand for loans is driven by “Americans who could get a loan, but are paying down debt.” Workers are contracting demand as they shift from spending to saving. 

Analysis 

The optimal policy solution for this crisis is another round of quantitative easing that targets debtors’ mortgages based on a progressive scale of debt held relative to income. The Fed would buy up private debt -- but while banks and other loaning institutions hold the debt itself, QE3 would distribute money to those who owe. If trends hold, the additional cash will aid savers, incentivizing them to spend more, raising aggregate demand. The only alternative is that debtors defy current trends and spend anyway, which seems unlikely. 

Next Steps 

The Federal Reserve should work directly with both U.S. consumers and financial institutions to institute a quantitative easing program that targets consumer debt based on a progressive scale of debt held relative to income. The Federal Reserve should supplement this action by continuing to lower interest rates and manage targeted inflation that reduces the debt burden on U.S. consumers.