Not a good metaphor for monetary policy
I know that the acronym, QE2, for Quantitative Easing 2 must have been irresistible, but it has been unfortunate. By making open market purchases, which should be routine, sound like such a big harry deal—printing money, debasing the currency, etc.—the term has, temporarily at least, delayed needed policy adjustments.
Contrary to popular opinion, money growth has been slow, not rapid, and measures of inflation have been falling, not rising. QE1 added greatly to bank reserves, which bloated the traditional measure of the monetary base, but most of those bank reserves have not yet led to rapid monetary expansion that would be inflationary. Banks are holding most of them as excess reserves—as precautionary balances.
Perhaps the monetary base has traditionally been considered one of the monetary aggregates, but its importance has always been that it is the raw material from which money can be created. It is not spendable money already. People don’t go out and spend the monetary base.
The Fed’s balance sheet has shrunk from its $2.3 trillion peak. If this continues it will represent a massive tightening of monetary policy at a time when the recovery is weakening and fragile. The Fed needs to be able to add to bank reserves without scaring the begeezes out of people who have been frightened by the QE2 bogey man. It doesn’t need to announce how much or over what time frame. It needs to return monetary policy to a routine that does not encourage scary headlines.
The Fed, of course, is partly to blame for the box that it’s in. There was no good reason that open market purchases should be considered routine and non-threatening if the target Fed-funds rate is above a certain level and the end of the world below that level. People call it printing money in the latter case, but the Fed always “prints money” when it makes open market purchases. The question is not whether it prints money, but how much. Too much is inflationary. Too little is disinflationary. Way too little is deflationary. In my opinion we are on the cusp of too little and way too little.
This is where the “you can lead a horse to water, but you can’t make him drink” argument comes in. If banks aren’t using their excess reserves to lend and create money, more reserves won’t help. I say less will help even less. If you are having trouble pushing on a string successfully, the solution isn’t to pull it in the opposite direction.
Like most everything else, holding money has diminishing marginal utility. At some point more money held will add less to total utility than alternative uses for it—i.e. lending or investing.
I don’t think more open market purchases will be a magic bullet. Monetary easing which includes downward movement of short-term interest rates must surely be more effective than monetary easing without downward movement of short-term interest rates. More bullets would be better, but interest rates aren’t the only bullets. It’s interesting how pundits that carefully avoid sounding “Keynesian” in other respects are totally Keynesian in equating monetary policy with interest policy and nothing else.
Actually, while I think monetary policy should be eased in some respects, I think that slightly higher interest rates would be desirable. We always know, but don’t often talk about it, that very low interest rates harm savers, particularly retired savers who depend on interest on bank deposits for income. Super low interest rates are usually temporary and most consider their help to borrowers and spenders to more than offset the harm to savers. But, in the present case, interest rates have probably been too low for too long.
Surely, Bernanke and Company could find a way to allow rates to rise a bit while making bank reserves more freely available. What I’m suggesting is allowing interest rates to rise within the context of continued monetary accommodation. I don’t know how to do that, but I’m pretty sure it would involve managing public expectations, or at least pundit expectations. If anyone can do that, surely Mr. Bernanke can, given the resourcefulness he demonstrated during the financial crisis.