The economic recovery is slowing after the first, inventory-driven, phase of the recovery. That is normal. What is not normal is persistently high unemployment — 9.6% in the US. And so the policy debate has come to revolve around what should be done to reduce the unemployment rate.

The liberal (in the US sense) economists that I follow, and who have generally given a better account of the crisis so far and what to do about it, are encouraging the Federal Reserve to do more to reduce unemployment, which means more quantitative or credit easing, at the same time as they despair at the political impossibility of further fiscal stimulus (Barack Obama’s latest package is just tinkering at the edges, is designed for political gain before November’s mid-term election, and has a good chance of not being passed).

For once, I am not sure that they are right. The idea that uncertainty over the regulatory and fiscal environment is discouraging businesses from hiring, which is the current favoured story of the Republican party (currently the party of stupidity), is not especially convincing, because the size out the output gap and the weakness of consumer demand seem to provide a good explanation in themselves. But even so, what can the Fed do about it? Considering the lack of demand for credit, it is not clear how much of an effect further QE would have; in any case, it would have to be very large to have an impact. The main benefit would probably be a reduction in long-term interest rates, which are anyway falling at present. And critics of further QE do have a  point when they say that it threatens the independence of the central bank, and that there is a danger that monetization of the government deficit could change from an emergency measure into a persistent bad habit.

Further, even if QE was successful in stimulating demand, it would be at the cost of balance sheet repair: rather than paying down debt, households and firms would be spending more money. The hope would be that this would be enough to kick-start the economy and allow debt to be paid down later, or that incomes would eventually rise enough to make debts more manageable. But in the present post-bubble environment it is more likely that further QE would work by promoting investment by firms in capital goods that they would subsequently not need as the economy remained weak. Whatever extraordinary steps the authorities may take in the short run to keep the show on the road, in the long run balance-sheet repair is the only way out of this crisis.

It is also true that some unemployment results from structural problems: people trapped in negative equity and unable to move to find new jobs, people trained as builders who now need to re-train as something else, and so on. This is far from being the whole story of unemployment, but it is questionable whether unemployment that is strictly cyclical is high enough, and could be sufficiently reduced, by further Fed action to outweigh the costs of further QE; the answer is not so obviously “yes” as to make further action a no-brainer.

Consequently, the Fed will probably hold off from further QE unless the banking system experiences futher chaos and thereby makes it a necessity.

There is more on this question here (Mark Thoma).