Matt O'Brien vs. Martin Feldstein on Quantitative Easing
There are two things you need to know about the Federal Reserve right now. First, it's had to resort to unconventional measures ever since short-term interest rates, its usual policy lever, fell to zero back in 2008. And second, everything you've been told about these unconventional measures has been wrong. The wrong story… the Fed has cut long-term rates by buying long-term bonds…. Lower borrowing costs should mean more borrowing, and more borrowing should mean more growth…. It's the same story you always hear… it's the one Harvard professor and former Reagan adviser Marty Feldstein tells in the Wall Street Journal. Well, kind of. Feldstein worries this story has some unintended consequences -- namely, higher deficits and higher inflation -- that will give it an unhappy ending….
The problem with Feldstein's argument is it ignores all empirical evidence, and, in the process, gets things completely backward. Quantitative easing doesn't lower interest rates. It raises them….
[M[onetary policy is more about expectations than interest rates. The latter just tell us about the former…. [B]uying bonds should lower interest rates, but it doesn't when it's the Fed doing the buying. It doesn't because the Fed isn't really buying bonds as much as it's sending a message that it wants more growth….
In normal times, savings gets turned into investment, but we don't live in normal times; desired savings has outpaced desired investment. That's why we're in a slump…. [E]verybody can't save at the same time. Your spending is my income, and vice versa….
[I]nflation. There's not as much to say here, because Feldstein's worries are entirely hypothetical. Yes, the Fed's balance sheet has swollen to an unprecedented size, but, no, that does not necessarily condemn us to a stagflationary nightmare of a future. Far from it. In theory, banks might want to lend out their $1.4 trillion or so of excess reserves when the economy recovers, but in practice there's plenty the Fed can do to forestall such an inflationary wave…. [I]t could increase the reserve requirement for banks, so those excess reserves just become reserves. In any case, markets aren't worried -- 5-year inflation expectations are hovering right around 2 percent.
There isn't a more maligned or misunderstood policy than quantitative easing. Scaremongers from Zerohedge to bond guru Bill Gross to Harvard professor Marty Feldstein have told us it subsidizes mega-deficits by pushing interest rates "artificially" low, and risks turning us into Zimbabwe, but the opposite is true. Quantitative easing lowers deficits, raises interest rates, and hasn't even pushed inflation above the Fed's 2 percent target. Now you know, and knowing, in this case, is all the battle.
