QE2 and Palin Redux
Allow me to second Paul Krugman’s amused reaction to the poor Wall Street Journal’s reaction to being lambasted by Sarah Palin.
What did they expect?
After her attack on Ben Bernanke and QE2, which was incorrect in theory, but correct as to likely effects, the WSJ pulled out its textbook and lectured her on how wrong she was. QE2 is standard, if unconventional, monetary policy, and has already had the textbook effect of lowering interest rates and lifting the stock market.
No matter.
Sarah lashed out at the WSJ as if it were someone left wing conspirator bent on stopping the Tea Party march towards nirvana.
The poor old WSJ, not above bending facts to fit it right wing agenda, blustered back at the odd feeling of being attacked by one of its own. What made it even more amusing was that part of its bluster was that it was relying on facts not opinion as it debunked the Palin line of argument.
Since when have facts been a problem for the right winger attack on reasonable policy?
In any case: according to the clinical interpretation QE2 has had exactly the required impact. It reduced interest rates, as monetary policy should. And the stock market seemed to be happy at the prospect of those lower rates boosting business profits.
My point, and one which I am certain eludes Palin, is that while we are stuck in the economic equivalent of no man’s land – in a liquidity trap – no amount of huffing and puffing by the Fed will create much movement. Yes, the policy seems to be working as expected. So what? It’s an ineffective policy. If companies wanted to invest they would. They are sitting on wads of cash. So lowering the cost of borrowing in order to induce investment is akin to pushing on a string. I hope it works. It probably won’t.
But that wasn’t what Palin was attacking.
She was criticizing the Fed for injecting cash into the economy and thus stoking inflation. That’s just asinine. We are in imminent danger of dropping into deflation. Besides, a burst of inflation would be a good thing. It would create the circumstances for us to have highly negative real interest rates which is what we need. Think about that: let’s assume that right now we have inflation of 1.5% and nominal (i.e. not adjusted for inflation) rates of 0.5%. Combine the two and we see real rates are -1.0%. That’s not low enough. We need to get to the -5.0% range given our level of unemployment. Obviously, the higher inflation gets – temporarily – the lower real rates drop. So with inflation of 5.0% and nominal rates at that 0.5% we would have real rates of -4.5%. Much closer to our target. Thus getting some inflation helps us a lot and allows us to float the economy off the rocks it is now firmly stuck on.
Hence inflation is our friend not our enemy at present.
But. Will we get there?
No.
And that is the reason I am skeptical about QE2. With the level of over capacity we have – idle factories and unemployed workers etc – there is no way an infusion of cash would ignite inflation alone. The best way to do that is to raise expectations in the market by actively adjusting the Fed target range, which is now 1.5% to 2.0% and thus much too low. The Fed has to talk inflation up by setting a higher target and then acting to get there. That would persuade businesses to invest now rather than later, and would add that extra oomph to QE2 currently lacking.
None of this surprises anyone schooled in Keynesian economics. Unfortunately we are run by an elite schooled in free market dogma. Thus we stay stuck on those rocks. And Palin rants on.
