This morning’s announcement of the third round of large-scale bond purchases, or quantitative easing, by the Federal Reserve is better than might be expected but not as effective as it might have been.
The good: QE3 is open-ended. The bond purchases, which will keep interest rates low, will continue until the economy improves. The first two QE rounds and “Operation Twist” were limited in their size. The new action sends the right message that the Fed will be engaged until the economy, and specifically the jobs crisis, improves. It says, in the words of San Francisco Fed President John Williams, “it’s vital that we keep the monetary policy throttle wide open.”
The less good is the central bank’s continued unwillingness to specify a higher inflation target, as much as 4 percent, which would be even more effective. This is among the measures that Chairman Ben Bernanke urged on the Bank of Japan during that country’s Lost Decade. But that was when he was a professor.
With the collapse of demand and overhang of debt from the Great Recession, runaway inflation is not a danger (as the past four years have shown). Indeed, the Fed’s easing has been caught in a liquidity trap, where monetary policy is much less effective. A higher target would eliminate any ambiguity that the Fed will stick with expansion.
This will be a big hit on Wall Street. Some of that will come from hot-money plays that do nothing to create jobs. The Fed’s action is less effective when federal fiscal policy is tilting to austerity. And it will no doubt be criticized by some as Bernanke injecting the central bank into the presidential race and trying to help President Obama. Instead, it’s an affirmation of the central bank’s independence, and a focus on getting growth and employment going again when millions are suffering. It’s long overdue.