Smith Faculty Opinion Article
The 30 Seconds Outlook
November 1, 2010
“What would be your winning formula today? . . . “Pro-growth tax
policies, stable exchange rates.”
— Professor Robert Mundell, in Judy Shelton, Wall Street Journal, October
16, 2010
The Fed favors a second round of Quantitative Easing to lower real interest
rates in hopes of stimulating loan demand and consumer spending.
With the Fed’s Quantitative Easing apparently on the way, this is a good time
to see what historical research and experience has to say about this and other
monetary policy issues:
- There has been no effort to improve the global economy by
stabilizing the euro-dollar exchange rate.
- Inflation targeting while ignoring the falling dollar exchange
rate and the large increase in the price of gold.
- A falling dollar exchange rate is the first signal of coming
inflation.
- The increasing price of gold reflects inflation expectations.
- Loose money policy and low interest rates have driven investors to
take on more risk and leverage seeking higher returns.
- Continuing to make both types of basic monetary policy errors: (1)
giving in to political interference and pressure and (2) basing policy on
mistaken beliefs.
- Failure to follow the money policy that worked during Volker’s
Great Moderation: (1) Fed independence was restored and (2) rules-based
interest rate policy was followed.
- Being unable to reduce additional excess bank reserves fast enough
to prevent inflation.
- A sustained deflation is most unlikely with a falling dollar,
unsustainable budget deficit and excessive bank reserves—this combination
points to inflation.
- Additional easing will not (a) increase employment, (b) increase
wages, (c) grow supply of credit, (d) increase demand for credit, (e)
strengthen community banks, and (f) increase lending to small business.
- There is no shortage of liquidity--large banks have huge amounts
of excess reserves parked with the Fed at interest and large investments in
Treasury bonds.
- Additional bank liquidity on top of excess liquidity will not
increase the demand for credit—it’s like “pushing on a string” when interest
rates are already basically zero.
- Increasing inflation will reduce the purchasing power of consumer
income.
The real motive for additional easing is to provide cover for another
“backdoor bank bailout” that includes Fed purchases of “toxic assets”
(mortgage-backed securities) at above market prices.
John A. Haslem
