The Federal Reserve made a colossal gamble with its so-called “Quantitative Easing” or “QE,” which is simply a euphemism for its $4.4 trillion binge of buying long-term bonds and mortgages. Its big bid for long bonds, along with parallel programs undertaken by other members of the international fraternity of central banks, has artificially suppressed long-term interest rates, and has deliberately fostered asset-price inflations in bonds, stocks, and houses.
Will this gamble pan out?
As central banks go, the Federal Reserve is one of the best. Much academic literature suggests that one of the reasons for its relative success is its relative political independence and freedom from partisanship. Central banks that are partisan or politicized are likely to engineer booms to elect the candidates of their party even if those booms have unfortunate long run effects on the nation. The classic case is a bank that pursues a loose money policy in the run up to the election to create a false sense of prosperity or to enable the party in power to finance…
The Federal Reserve Board seeks to maintain an inflation rate around two percent per year. While this rate might sound low for older types who remember double-digit inflation rates in the late 70s and early 80s, and a rate of 5.4 percent as recently as 1990, why tolerate, let alone seek to sustain, any inflation at all? Why not seek to establish zero inflation and stable prices? After all, even an inflation rate of only two percent a year means nominal prices still double every 36 years. And while people can and do broadly adjust their behavior in the face of anticipated inflation, it’s not a seamless process. Inflation distorts people’s economic decisions, whether as producers or consumers, labor or capital, and so imposes costs on us all.
The balance sheet of today’s Federal Reserve makes it the largest 1980s-model savings and loan in the world, with a giant portfolio of long-term, fixed rate mortgage securities combined with floating rate deposits. This would certainly have astonished the legislative fathers of the Federal Reserve Act like Congressman and then Senator Carter Glass, who strongly held that the Fed should primarily be about discounting short-term commercial notes.