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Goldman Sachs predicts another $2 trillion of QE

Investment bank Goldman Sachs is forecasting that the Federal Reserve will eventually be forced to release $2 trillion more in quantitative easing to support the faltering US economy.

The bank said that based on its own analysis the Fed ought to pump in a further $4 trillion in order to achieve the monetary easing the economy needs, a sum which it estimates would be equivalent to a cut in interest rates of 3%.

However, it concedes that the bank is highly unlikely to release that much money and even the money it does release it believes will come more slowly than many anticipate.

The Federal Reserve's Federal Open Market Committee (FOMC) is set to meet on the 2-3 November and is widely anticipated to announce further quantitative easing.

Goldman analyst Jon Hatzius argues that while more quantitative easing could achieve the same objective as rate cuts the Fed will focus on the tail risks associated with the move.

He said: 'These risks include the possibility of substantial mark to market losses on the Fed's investment, which might prove embarrassing in the Fed's dealings with Congress and could, in theory, undermine its independence. They also include the possibility that the associated sharp increase in the monetary base will lead households and firms to expect much higher inflation at some point in future.'

Hatzius believes the likely amount of QE that will ultimately be released by the Federal Reserve is based therefore on an equation balancing what is needed with the level of policy risk that the central bank is willing to accept.

He estimates that that risk level represents at any given time an amount of money being released equivalent to the economic impact of a 1% cut in interest rates.

He said: 'Should the FOMC be willing to tolerate the same policy gap going forward [as it has in the past] - and thus only close 200 basis points of the 300 basis points policy gap - the appropriate amount of additional [QE] would be almost $3 trillion.''

However, Hatzius argues that rather than releasing these $3 trillion the bank will attempt to close some of the policy gap by announcing its intention to keep rates low for a prolonged period of time.

He concludes: 'Our analysis is therefore consistent with additional asset purchases of around $2 trillion if the FOMC's forecasts converge with our own. It is unlikely, however, that the FOMC will announce asset purchases of this size in the near term. Rather, our analysis suggests that the timing of the announcement should depend on whether, and how quickly, the FOMC's forecasts converge with our own.'

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