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Thursday, July 26, 2012

Benefits of More Fed “Action” Do Not Exceed Costs

Both the New York Times and the Wall Street Journal ran front page stories yesterday reporting that the Fed is yet again about to take action. “Fragile Economy Said to Push Fed to Weigh Action” said the Times. “Fed Moves Closer to Action” said the Journal. Both stories report that the benefits of such actions in the past have exceeded the costs, but there is precious little evidence for this. In an interview in the latest issue of MONEY Magazine I was asked about this:

What’s your assessment of the Federal Reserve’s recent actions to help spur the economy?  The Fed has engaged in extraordinarily loose monetary policy, including two round s of so-called quantitative easing. These large scale purchases of mortgages and Treasury debt were aimed at lifting the value of those securities, thereby bringing down interest rates. I believe quantitative easing has been ineffective at best, and potentially harmful.

Harmful how? The Fed has effectively replaced large segments of the market with itself—it bought 77% of new federal debt in 2011. By doing so, it creates great uncertainty about the impact of its actions on inflation, the dollar and the economy. The very existence of quantitative easing as a policy tool creates uncertainty and volatility, as traders speculate on whether and when the Fed is going to intervene again. It’s bad for the U.S. stock market, which is supposed to reflect the earnings of corporations.

On a more technical level, the latest issue of the International Journal of Central Banking published an article by Johannes Stroebel and me raising doubts about the benefits of the mortgage-backed securities (MBS) purchase program (part of QE1), and the costs of the resulting large balance sheet go well beyond concerns about inflation.