Debate Club

Quantitative Easing Inappropriately Expands the Fed's Reach

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Over the last four years, the Federal Reserve has acquired new and unprecedented powers as well as almost tripling the size of its balance sheet. Even if one believes this was necessary to deal with the financial crisis, and I do not, the more the Fed grows, the harder it will be to remove those powers and shrink its balance sheet when and if normal conditions return. If one believes, as I do, that the Fed was also one of the institutions primarily responsible for generating the housing boom and subsequent recession, then expanding its reach, especially when it is unlikely to ever shrink, is akin to hiring an arsonist as a firefighter.

In addition, the previous rounds of quantitative easing have done little to nothing to generate recovery. Of course it's always possible that it's because it wasn't enough, but a tripling of the Fed's balance sheet hardly seems like an insufficient attempt at monetary stimulus.

[See a collection of political cartoons on the economy.]

Among the arguments for additional monetary stimulus is that the economy remains below the ideal growth path for nominal Gross Domestic Product (NGDP). The dramatic increase in the demand for money during the fall of 2008 meant that the then-current supply of money was insufficient to maintain GDP growth. It's quite possible that the supply has yet to catch up, but the problem with this argument is that most economic theories explaining why an insufficient money supply would lead to recession depend upon "stickiness" in prices and wages. Those same theories also indicate that, after a sufficient amount of time, people will adjust to that stickiness in prices and wages and the money supply will be sufficient again.

If that adjustment hasn't taken place in almost four years, then perhaps it is not this "stickiness" that could perhaps be overcome by more monetary stimulus, but rather real resource misallocations that are causing delaying recovery. Those real misallocations cannot be fixed by more money. Instead, we need less regulation and more freedom for entrepreneurs to reallocate resources away from the mistakes of the boom, to where they are most valuable now.

Finally, although inflation has not reared its ugly head yet, the current enormous supply of reserves sitting in banks is an inflationary time bomb. Adding additional reserves through another round of quantitative easing would increase the potential damage should inflation begin to appear.

Steven Horwitz

About Steven Horwitz Mercatus Center Senior Affiliated Scholar

Tags
Federal Reserve
economy

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