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Q&A with OU Professor Robert Dauffenbach on the economies of Oklahoma and the U.S.

By Ian Ogilvie Modified: March 23, 2013 at 12:10 am •  Published: March 24, 2013
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Q: So what do you see looking ahead for Oklahoma and the U. S.?

A: In my view, we're still kind of on the cusp of recession nationally, and economic indicators have been mixed. The jury is still out on what all the indicators mean taken together, but recent signals like the February jobs number suggest the economy is strengthening.

In terms of employment, it's been a long slog back from the financial crisis, and we're not there yet. With rates of employment growth in the recovery, the U.S. will not get back to its 2008 peak employment, in absolute numbers of jobs, until sometime in 2015. And that doesn't even take into account a labor force that will be 7 to 8 percent larger by then. Should employment growth remain steady or increase in the U.S., things should continue to look relatively good for Oklahoma. We will do well to match the gains of 2012 this year, but we certainly have a good shot at it with the continuing natural gas and tight oil boom.

But an economist always needs to be looking at what the next problem might be. In my view, that potential concern is inflation brought on by the Fed's quantitative easing programs.

Q: Quantitative easing is a term that everyone has heard of but few understand. Please briefly and simply explain quantitative easing, and why it might lead to inflation.

A: Bear with me because it is a little complex. Quantitative easing involves the Fed buying bonds from banks and other financial institutions using money that the Fed creates out of “thin air.” I'm not talking about the debt of the banks themselves, but bonds that they own, like an individual would own bonds. When the Fed buys bonds, it pays for them by simply adding to the deposits the banks have at the Fed. The Fed gets the bonds and the banks get newly created deposits at the Fed. The Fed's assets, including bonds, have expanded from $900 billion in 2007 to over $3 trillion today.

Why am I concerned about inflation? It is because these bank reserves are “high powered money” capable of being lent-out multiple times thereby leading to multiple expansion of the money supply. We have a fractional reserve system — banks are only required to keep a small amount of reserves relative to what they can lend out. The more reserves a bank has, the more it can lend. And each time a bank lends money, the money is spent and becomes a deposit at another bank, in turn increasing that bank's reserves, most of which is available to be lent out. That process is repeated again and again in what is known as the “money multiplier effect.”

The concern is that eventually this money being deposited into banks' accounts at the Fed will result in more money in circulation as those deposits are increasingly lent out by the banks, compounded by the multiplier effect. More money may mean, potentially, too much money chasing too few goods, i.e., inflation.

Q: What can we can as individuals do?

A: It's critical that people take time to understand what the Fed is doing, because its actions may be more consequential than most of us and our elected representatives realize. I applaud the Fed for preventing a deflationary crash in 2008, but it may have overdone it with quantitative easing at this point. It may be difficult for the Fed to sell the debt it now owns — unwind its positions — without interest rates going higher. This is because when the Fed sells bonds, the price of bonds fall and interest rates rise. Investors demand to be paid more to own a larger stock of bonds. Higher interest rates could hurt the economy.

The Fed has never embarked on a program of this magnitude, and it will be tricky going from here. We can help ourselves by trying to understand the Fed, and by being vigilant about inflation, and by encouraging our elected officials to understand and uncover what the Fed is doing. We should give their words and deeds proper scrutiny because inflation is a tax, and a serious threat to stability and prosperity.


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