The Federal Reserve appears poised to launch another round of “quantitative easing” in early November in which it will purchase long-term Treasury securities with newly minted dollars. What will be the good, bad, or possibly ugly?
Facing an economy struggling with high unemployment and inflation running below desired levels, many monetary policy officials feel compelled to “do something”. Fiscal policy is constrained by a growing federal debt while Congress could be even more gridlocked after the elections.
Purchases of government bonds should put downward pressure on a number of long-term interest rates, including mortgage rates and corporate funding costs. Indeed, expectations of the Fed’s purchases have already driven rates lower. While these actions may have some effect in boosting consumer and business spending, the impact is likely to be small. The primary problems facing the U.S. economy are not interest rates that are too high or a lack of liquidity but rather uncertainties and anxieties relating to various economic policies and the strength of the recovery. Meanwhile, some of the positive effect of lower interest rates could be offset by a higher cost of food, commodities, and imported goods.
The risk of negative consequences is significant. The pumping of large amounts of dollars into financial markets could continue to drive prices of various assets, including those of gold, other commodities, and bonds to “bubble” heights. A rapid inflow of funds into emerging markets could lead to overheating in those areas. A major revival of risk taking and debt could renew old imbalances. A further growth of the Fed’s balance sheet beyond its current $2.3 trillion could also raise the threat of a sizable rise in future inflation.
Finally, the downward pressure on the dollar from the expectation of a new round of money creation has stoked a wave of currency wars and protective or retaliatory moves. This is not a pretty outcome.