Thursday, March 19, 2009

Ben's $1.2 Trilion Bet

Posted Thursday, March 19, 2009

Monetary Policy: The Federal Reserve's plan to create $1.2 trillion out of thin air to buy Treasuries is a risky move, to say the least. If it doesn't boost output by an equal amount, the certain result will be inflation.

Desperate times breed desperate measures, and clearly that's very much on the mind of Fed chief Ben Bernanke. On Wednesday he announced the Fed will print money to buy U.S. Treasuries in unheard-of amounts — nearly $1.2 trillion.

This move, so-called "quantitative easing," is both momentous and perilous. With interest rates now at zero, it's the only real arrow in the Fed's quiver to fight a deflationary economy.

But why is the Fed doing this now?

An academic expert on the Depression, Bernanke no doubt understands that the government during the 1930s did too much tax-hiking, tinkering and regulating, and too little on the monetary side of things, and that this was a big reason why the economy collapsed.

He's well aware that other experts, such as Milton Friedman and Anna Schwartz in their monumental 1963 tome on U.S. monetary policy, laid much of the blame for the economy's collapse in the '30s on Federal Reserve wrongheadedness.

And indeed, since the Fed let money supply contract more than 30% as the economy plunged 27%, it's hard to argue that fact. Bernanke hopes to avoid the same mistakes.

That said, we face a far different situation today, with neither a GDP down 27% nor a quarter of our people out of work.

More appropriate, however, is the experience the last time the Fed tried quantitative easing in 1961—in the so-called "Operation Twist." According to the Fed's own later assessment, it failed.

In the end, what did work were the broad-based tax cuts pushed by President Kennedy and passed after his death. That's how that booming decade became known as the "go-go" years.
Perhaps Bernanke sees an administration and a Congress recklessly layering on new spending, new regulations and needless government programs that will inevitably slow growth and crimp productivity. Absent any real stimulus, such as tax cuts, he may feel quantitative easing is a risk worth taking.
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