Fed and QE

There’s been a lot in the news about the potential for tapering (easing off on the $85 Billion in asset purchases the Fed has been making each month) to begin within the next several FOMC meetings. In light of that fact, I think it’s worth taking a closer look at Fed behavior:

From the Fed’s legal mandate:

“The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.”

To parse that into more common terms, that means the Fed has a legal mandate to promote full employment, stable prices (2% inflation), and moderate long term interest rates. So let’s check out how the Fed has been doing–From FRED:

Ok, so unemployment is elevated and inflation is running below target–if the overnight lending rate (the main tool that the Fed uses to control monetary policy) were 10% right now, it would be a no-brainer for the Fed to lower the overnight lending rate. Unfortunately, the overnight lending rate is at 0%, so the Fed has had to engage in unconventional monetary policy in order to stimulate the economy. It has done so, and it has been moderately successful (see declining unemployment rate above). However, with unemployment still elevated, and inflation under control (falling), we should at the minimum be maintaining current policy. Let’s take a look at what the Fed has managed to do over the past two months by contemplating tapering quantitative easing:

From Brad Delong:

Screenshot 7 10 13 11 30 AM

This is a mistake from the Fed–and the consequences of this communication mistake will be far worse than any potential damage from continuing QE might have been.


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