http://www.washingtonpost.com/wp-dyn/content/article/2010/11/03/AR2010110307372.html
Will it work? For a monetary stimulus to actually stimulate the economy, it has to change how consumers behave. Since consumers do not get any of the cash directly, the only instrument that the Fed can hope to affect is interest rates. In theory, the monetary stimulus will push down interest rates and thus unleash more borrowing by consumers and companies. I see four problems:
1. Level of interest rates: If short term rates were 5% and long term rates were 7%, I can see the potential for lower interest rates inducing more borrowing and higher consumption. But short term rates are already close to zero and long term rates are at historic lows. If people are not borrowing money at 4% (long term mortgage rates are down to that), what makes the Fed think that a 3.5% rate will induce them to do so? As for companies borrowing money, why should they when they are sitting on huge cash balances?
2. Existing leverage: The average US household already has too much debt, some of it reflecting a hang over from excessive credit card and other borrowing in the good times and a great deal of it a result of the housing boom and bust. Assuming QE2 works, is it a good idea to induce consumers to borrow more? It may create some short term growth, but are we not setting ourselves up for the next bubble bursting?
3. Inflation fears: The power of monetary stimulus rests on the credibility of the central bank. If investors trust the central bank to keep inflation in check in the long term, they will respond to the stimulus by lowering interest rates. If, on the other hand, that trust is lost, a stimulus can actually be counter productive. The pumping of money into a system that is already flush with cash and facing potential deficits down the road will raise the inflation bogeyman, which in turn will push up interest rates. I am not convinced by Bernanke's twin rejoinders: that existing inflation is very low and that the last stimulus did not create inflation. That was because the last stimulus did not work. If this one does, then what?
4. Currency devaluation: Related to inflation fears is the effect on the US dollar, which has been under selling pressure for a while. A dollar devaluation will also make imported goods more expensive in the US, and given the trade deficit, that has to feed into price increases in the future.
Having listed these concerns, I must confess I am not a macro economist (and have no desire to be part of that crew). The Fed presumably has access to "experts", who have thought through all of these issues and decided that the benefits overwhelm the costs. At least, I hope so...
I don't know about you, but I am starting to wonder about these multiple stimuli. Using the analogy of the emergency room, those electric paddles used to shock a faltering heart back into a rhythm are a godsend for someone with cardiac arrhythmia, but I also know that they sometimes do not work. That is when the cardiac surgeon is called in for more radical remedies or worse. To stimulate the US economy, we tried QE1 and it did not work, we tried FS1 (Fiscal Stimulus 1) and it did not work either. Now we are trying QE2 and if we listen to Paul Krugman (who must be having seances with Keynes every night), we should try mega FS2 next...Perhaps, it is time to accept the reality that there is something fundamentally wrong with the economy that stimuli will not fix. And perhaps, it is time to call in the surgeons! (Let's not even think about the other alternative)
And for those of you who may be wondering about the title of this post, here is the original QE2.
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