Economics, Monetary Policy

Fed stops firing blanks

The Fed refrained from any additional QE or twist easing today even as it acknowledged a still weakening U.S. economy. Why would a central bank not signal further easing with a slowing economy and falling inflation? The answer: A reluctance to announce further easing when the probable outcome would be no impact on growth or the unemployment rate and more criticism from those who say the Fed is risking more inflation.

With short term interest rates at zero and long term rates at record lows and negative in real terms, having the Fed buy more long term treasury securities (via QE3 or operation twist) isn’t going to make firms hire or invest more or make households spend more out of rising cash holdings until uncertainty about the U.S. “fiscal cliff” (currently scheduled fiscal drag at yearend worth 4 percent off GDP growth), and the euro crisis  are resolved. The precautionary motive-hold cash and add to cash in the face of rising uncertainty -has created a liquidity trap that renders monetary policy useless as a means to lower unemployment. On the positive side,It also means that more money creation doesn’t boost inflation, hence the drop in inflation while money printing has continued.

Even the portfolio route of pushing interest rates to  zero to try to get yield-hungry investors to take more risk and buy more stocks has been played out. Rising uncertainty breeds absolute liquidity preference that manifests itself in “cash hoarding” so prevalent among households and businesses today.

The Fed can’t make the “fiscal cliff” go away. Nor can it resolve the euro crisis. The best it can do for now is sit tight and not add to the current damaging level of uncertainty by trying another round of QE that has no positive impact on the economy.

One thought on “Fed stops firing blanks

  1. “Fed is risking more inflation”?
    Funny. The Fed CAUSES inflation. They create “money” from nothing and charge interest on it. If it hasn’t already happened, the “debt” is more than the total money.

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