One should expect unprecedented economic situations to lead to unprecedented economic policies. For the most part, the US Federal Reserve didn't create the Great Recession ( the Greenspan Fed may have contributed to the real estate bubble in some measure, but one should keep in mind that it is difficult for Fed policy alone to create asset bubbles like real estate bubbles if most economic agents are acting " rationally " most of the time. Also, the Greenspan Fed may have had other valid justifications for its interest rate policies ). It responded to it. The Great Recession has similarities with the Great Depression, but it isn't the same as the Great Depression. There is nothing in economic science to provide exact guidance for Fed policies during these difficult economic times.
Those who swear by rigid anti-inflationary principles ( http://www.bloomberg.com/news/2012-10-31/bernanke-depression-guru-seeks-roosevelt-well-being.html ) would do well to realize that these are indeed unprecedented times. This article is not trying to defend specific asset purchases of the Fed. For example, excessive purchases of mortgage-backed securities during QEs, as opposed to buying more Treasuries worth the same value, is indeed a risky game. And it should be scrutinized carefully. What this article is trying to say is that inflexible anti-inflationary stances are ill-suited during deep recessions and during long bouts of high unemployment.
As for the exact mix of securities that the Fed bought for its QE operations, that is something that experts need to think seriously about. Were all the QEs necessary ? Possibly. Were all the purchases of mortgage-backed securities for these QEs necessary ? That is a difficult question to answer. Can the US economy embark on a high-GDP-growth and an inflationary trajectory while the housing market is still down ? Or is the recovery of the housing market a sine-qua-non for inflationary pressures to build up in the US economy ? Once again, this is a difficult exercise in economic prognostication that requires serious research. Let it be said though, that if inflationary pressures build up without a corresponding recovery in the housing market, the MBSs held by the Fed will most likely not command much market value. To that extent, the Fed's ability to rein in inflation will be compromised in such a situation. This possibility of the inability of the Fed to have sufficient amount of effective assets to sell in case of inflationary pressures is something that monetary policy needs to contend with. Let it also be said that the European Central Bank's long-term-refinancing-operations may also leave it in a situation of weak control over prices if inflationary pressures build up. Both the US and the European monetary systems are dealing with new economic realities. The policy makers in charge of these monetary systems are learning many crucial things along the way. In the US, GDP growth is beginning to falter although it recovered to some extent after the GDP contraction during the Great Recession. The small business sector has shown persistent weakness. Even big corporations have been having difficulties. Why haven't the QEs led to more investment spending and more consumption spending than what we have seen ? What effect have the QEs had on activities in the credit market ( as regards rates and amounts of lending and borrowing and the quality of new credit in the economy ) and what effects are they likely to have in the credit market in the future ? These questions about the links between QEs and possible economic recovery need to be answered if we are to reach a better understanding, not just of the recent economic crises, but also of appropriate responses to possible future crises with similar causal factors and similar mechanisms.
by C. Jayant Praharaj ( send comments to [email protected] )
Those who swear by rigid anti-inflationary principles ( http://www.bloomberg.com/news/2012-10-31/bernanke-depression-guru-seeks-roosevelt-well-being.html ) would do well to realize that these are indeed unprecedented times. This article is not trying to defend specific asset purchases of the Fed. For example, excessive purchases of mortgage-backed securities during QEs, as opposed to buying more Treasuries worth the same value, is indeed a risky game. And it should be scrutinized carefully. What this article is trying to say is that inflexible anti-inflationary stances are ill-suited during deep recessions and during long bouts of high unemployment.
As for the exact mix of securities that the Fed bought for its QE operations, that is something that experts need to think seriously about. Were all the QEs necessary ? Possibly. Were all the purchases of mortgage-backed securities for these QEs necessary ? That is a difficult question to answer. Can the US economy embark on a high-GDP-growth and an inflationary trajectory while the housing market is still down ? Or is the recovery of the housing market a sine-qua-non for inflationary pressures to build up in the US economy ? Once again, this is a difficult exercise in economic prognostication that requires serious research. Let it be said though, that if inflationary pressures build up without a corresponding recovery in the housing market, the MBSs held by the Fed will most likely not command much market value. To that extent, the Fed's ability to rein in inflation will be compromised in such a situation. This possibility of the inability of the Fed to have sufficient amount of effective assets to sell in case of inflationary pressures is something that monetary policy needs to contend with. Let it also be said that the European Central Bank's long-term-refinancing-operations may also leave it in a situation of weak control over prices if inflationary pressures build up. Both the US and the European monetary systems are dealing with new economic realities. The policy makers in charge of these monetary systems are learning many crucial things along the way. In the US, GDP growth is beginning to falter although it recovered to some extent after the GDP contraction during the Great Recession. The small business sector has shown persistent weakness. Even big corporations have been having difficulties. Why haven't the QEs led to more investment spending and more consumption spending than what we have seen ? What effect have the QEs had on activities in the credit market ( as regards rates and amounts of lending and borrowing and the quality of new credit in the economy ) and what effects are they likely to have in the credit market in the future ? These questions about the links between QEs and possible economic recovery need to be answered if we are to reach a better understanding, not just of the recent economic crises, but also of appropriate responses to possible future crises with similar causal factors and similar mechanisms.
by C. Jayant Praharaj ( send comments to [email protected] )