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Department of Fun Post Titles: Quantitative Easing and the Federal Reserve

My colleague Neil Irwin has a nice piece on the state-of-play at the Federal Reserve:

Having pulled out every tool at its disposal to combat the recession and financial crisis, there is an open question about what kind of appetite Fed leaders might have for further action. On one hand, the economy is now declining at a more measured rate than it was this winter. On the other, the economy remains in decline.

The most obvious way the Fed could escalate its response would be to expand or speed up its planned purchase of $300 billion in long-term Treasury bonds. That step would help reduce long-term interest rates for the U.S. government and, if it works as intended, businesses and consumers. Long-term Treasury rates have risen in recent weeks, reflecting in part the improved economic outlook.

But the Fed purchases, a strategy known as quantitative easing, are controversial inside the central bank and out. Some officials worry that it could make it appear as though the Fed is printing money to support the government's giant budget deficits.

In this case, the Federal Reserve actually would be printing money to finance the government's giant budget deficits. But the point isn't to lower the deficit. It's to lower the interest rates that result from the deficit. The concern is that we're trading short-term growth for longer-term inflation (as the Federal Reserve is printing money to buy debt).

If you want a good explanation of how this works, the Financial Times released a helpful animation of the process. A quantitative easing cartoon, if you will. I'd rate it as worse than Family Guy, but substantially better than American Dad. On the other hand, if you feel like you're a Very Serious Grown-Up Who Doesn't Watch Cartoons Anymore, you can also read this paper arguing that Japan's experience with quantitative easing was, on net, negative.

By Ezra Klein  |  May 18, 2009; 3:00 PM ET
Categories:  Economic Policy  
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Comments

hey--sorry to be off topic, but do you know what this Roll Call article is referring to about the proposals Grassley and Baucus are releasing? I can't get past the jump.

http://www.rollcall.com/news/35013-1.html

Posted by: dailykos1 | May 18, 2009 3:49 PM | Report abuse

They have not done 'everything in their power.' Sometimes the best response is to to...nothing. If they did, perhaps we'd be right where we were, without having pi**ed a trillion or more dollars down the drain. 18 or so months ago, Bush sent out checks to everyone that did...nothing. Last summer they passed a stimulus that did...nothing. So in January/feb a new stimulus was passed that did...um, what exactly? Except increase our deficit?

Posted by: atlmom1234 | May 18, 2009 5:59 PM | Report abuse

welcome aboard, Ezra. Why couldn't the Fed do quantitative easing at ebay? Just start buying up tchotchkes with user name BigFed or BigBen. With paypal they could insert liquidity directly out of their bank account, right?

Posted by: bdballard | May 18, 2009 6:02 PM | Report abuse

Note that the "long term risk of inflation from 'printing money'" fear is based on a fantasy world where the printing of cash adds money to the money supply which cannot be readily withdrawn again.

Both of those are false ... money is printed as tap-issue when banks withdraw cash from federal reserve accounts and there are not enough notes on hand to meet the withdrawal ... which is to say, bills are printed to change the form of money that is already in existence ...

... while on the other hand, draining reserves from the system will end up reducing cash in circulation at the same time as total reserves shrink.

And, indeed, in buying Treasury securities, the Fed will be improving the quality of its balance sheet, which is now loaded will all manner of overvalued assets of dubious value after over two years of Bernanke's reckless experiment with buying and accepting low quality "assets" as a means of throwing liquidity at a solvency crisis.

The real problem with quantitative easing is different. Until the economy bottoms out, making credit more easily available will either mean (1) nothing, since banks shouldn't be lending to firms and individuals borrowing liquidity to try to paper over an underlying insolvency or (2) repeating the mistakes of this decade, as banks do lend to those that they should not lend to.

The time when "quantitative easing" can most benefit the economy is once the economy has bottomed out, in the early stages of the recovery.

Posted by: BruceMcF | May 19, 2009 12:44 PM | Report abuse

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