QUANTITATIVE EASING : CALM AFTER THE STORM / THE FINANCIAL TIMES LEX ( HIGHLY RECOMMENDED READING )

Quantitative easing: calm after the storm

Published: November 4 2010 09:58
Last updated: November 4 2010 17:23

Welcome to the brave new world of monetary policy. The US Federal Reserve’s decision to buy $600bn of government debt with newly created money is a great experiment. Unlike the asset purchases in the crisis of 2009, this time the Fed is portraying its decision, which is the equivalent of monetising at least 55 per cent of the government’s expected fiscal 2011 deficit, as a matter of normal policy.


Markets took the news in stride. A fairly modest 20 basis point rise in the yield on 30-year Treasury bonds was a reasonable response to the only real surprise: the decision to buy bonds with shorter maturities. The US stock market rose and the dollar fell, continuing the pattern established as imminent quantitative easing became a near certainty.


The relative calm belies a feverish excitement among the investing classes, as pundits and players argue about what it all means. Views range all the way from safe and sensible to dangerous and foolish.


The Fed’s defenders argue that the experiment is not really that novel. True, no other rich country has tried out this sort of QE in modern times, but this substitution of cash for debt is only a variation of a generally successful monetary technique, which has been honed over three decades of steadily falling bond yields. They say the government’s fiscal issues are all but irrelevant.


Attackers take a longer and more cynical historical view: however virtuously they began, pre-modern episodes of money creation almost all ended in inflationary tears. The Fed’s new printing, like the government’s new vast borrowing, may be justified by the desire to find jobs for idled workers. But the authorities are likely to overestimate how much and how fast US employment can fall. And spending without taxation or even borrowing can make politicians giddy.


The temptation to print too much for too long will be strong. If the Fed and the government do not have enough character to resist, this brave new world will prove a dystopia.


Copyright The Financial Times Limited 2010.