(photo credit: Associated Press)
If the medicine proves ineffective, just try a bigger dose, for longer. That has
been the essence of American monetary policy for the last several years, and it
was firmly reiterated on Wednesday night. The latest meeting of the Federal
Reserve Bank’s Federal Open Market Committee – the group of people who actually
decide monetary policy – was noteworthy for the introduction of further elements
of Chairman Ben Bernanke’s policy to increase openness and
One important element was the announcement of a defined
target for inflation: namely, an annual rate of increase of 2 percent in the
Fed’s preferred measure of consumer-price inflation. Another was the publication
of the views of all the 17 members of the FOMC, including the nonvoting ones, as
to when they think the first rise in interest rates will take place. The
majority, 11, see this occurring in 2014 or later, while three think it will
happen this year and three next year.
However, these revelations are not
very important. What matters is that in the accompanying statement the Fed
announced it had extended its existing policy of holding its key interest rate
at very close to zero from 2013 to 2014.
Why six members think that won’t
be the case – i.e., that the Fed will choose, or be obliged, to change its
policy this year or next – is an interesting side issue. The official policy
remains “very low for even longer.”
Furthermore, in the press conference
that followed the committee meeting – itself another innovation instituted by
Bernanke last year, to “improve communications” and “enhance transparency” – the
chairman was even more “dovish,” as the jargon terms it. He made it clear that
the bias of policy remains firmly in the direction of further easing. Since
rates are already almost zero, “further easing” means more “QE” (quantitative
easing), which, in plain language, means that the central bank buys bonds in the
open market, thereby pumping money into the economy.
There have already
been several rounds of QE, since the height of the financial crisis in early
2009. These are referred to by analysts as “QE1,” “QE2” and “QE lite,” the last
of which has been ongoing since last September.
There has been widespread
anticipation of “QE3,” but this has, so far, not been forthcoming. However,
Bernanke effectively promised to deliver it, if and when the economy does not
improve further – especially in the key area of unemployment.
background of massive additions of liquidity by the European Central Bank, the
intention of the Bank of England to engage in a further round of QE in its
bailiwick and the ongoing large-scale purchases by the Bank of Japan, it would
be strange if the Fed remained aloof.
Or perhaps not. After all, a
specific policy is pursued so as to achieve defined goals. There is considerable
debate and a large measure of skepticism regarding whether the policy of
quantitative easing has achieved its proclaimed goals of stimulating economic
growth and promoting recovery, higher employment and expanded
It is very likely that QE1 prevented the meltdown of the
global financial system in the 2008-09 crisis, but the impact of the subsequent
efforts, in the US and elsewhere, has generated diminishing returns – if any.
The money pumped in has tended to stay with the banks and not entered the wider
economy. It may well have spurred financial speculation and driven commodity
prices higher – and thereby contributed to inflation and, perhaps, to the surge
in food prices that led to the Arab Spring. But it has done precious little for
production, employment and the real economy.
What is certain is that the
policy of very low interest rates for a very long period carries with it heavy
costs. Many people, primarily pensioners, live from their investments (or their
pension funds’ investments), and these have been hammered by the fact that safe
investments generate virtually zero returns. To achieve a decent return on their
money, they are obliged to move to investment vehicles that carry higher risks
than they would like or that they should be exposed to.
Why, then, the
determination to continue with and even intensify the current policy? There are
several possible explanations. One is that Bernanke, the Fed and central banks
as a whole, truly believe that this policy is necessary and effective, so that
its costs are outweighed by its benefits. Another is that central banks and
bankers are not convinced of the efficacy of QE, but they firmly believe that
they must “do something,” and this kind of “unorthodox policy” is all that
remains for them, after they used the traditional tools at their
If, however, even QE proves to be no longer capable of making a
significant or lasting impact on the economy, or even the markets, then the
central-banking emperors will be revealed as having no