Yes, QE2 Is Uncharted Territory
In yesterday's Wall Street Journal, former Fed vice chairman Alan Blinder argued that QE2, the Fed's recent decision to buy $600 billion in bonds with newly created money, may not be terribly effective as stimulus, but is neither unprecedented nor particularly worrisome from an inflationary perspective. His basic argument was that the Fed buys bonds all the time and that unmanageable inflation isn't likely because current Fed Chairman Ben Bernanke probably won't be so inept as to let prices spin out of control. I'm always wary of the argument that we should put our faith in expert policymakers. But economists on both sides of the ideological spectrum disagree on the potential negative effects of the policy, so I recognize there's some room for disagreement on this front. Still, I think Blinder significantly underplayed the novelty of the Fed's decision, which a straight-news article in The Washington Post actually labeled "risky and untested." Indeed, I suspect the novelty of the Fed's move is part of the reason why expert reaction is so varied. Writing for the online think tank e21, Former Treasury official David Malpass has a helpful response to Blinder explaning why QE2 puts the Fed in uncharted territory:
Unfortunately, Dr. Blinder colors the debate at the outset, terming critics of the Federal Reserve "the economic equivalent of the Flat Earth Society" even though the Fed has suffered severe monetary and regulatory policy blunders over the years. Even after the housing bubble related to super-low Fed interest rates, the Fed has done little to rebuild confidence in its policy judgments.
In a garden variety monetary policy, the Fed owns short-term assets like Treasury bills, balanced by short-term borrowings from banks. Because the maturites are matched, interest rate increases would have little impact on the Fed's earnings or net worth. This assures the Fed a great deal of latitude in pursuing price stability, giving investors confidence that the Fed can sell Treasury bills and allow interest rates to rise as needed without itself losing money.
By buying longer term assets, whose value will decline when interest rates rise, the Fed is engineering a fundamental change in the nature of U.S. monetary policy. This has undercut global confidence in the Fed, as reflected in high gold prices, dollar weakness, and large-scale investments abroad by U.S. companies and wealthy individuals.
My look at the workings of QE2 here.
