After QE3 It’s Time to Rein in the Federal Reserve

Quantitative easing is a flawed way to attempt to revive the economy.

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For decades, the argument to exempt the Federal Reserve from government oversight has focused on protecting it from politicization. But the Fed's recent decision to indulge in yet another round of quantitative easing makes this argument borderline laughable. It's like saying that you are trying to avoid diabetes by only eating at fast food restaurants.

Now don't get me wrong, there has always been subtle pressure on the Fed to use monetary policy to artificially cushion (read "hide") economic downturns during a presidential election year. The difference in this case stems from a series of questionable actions and its potentially devastating implications for American seniors and savers.

A superb op-ed in Monday's Wall Street Journal authored by some of the leading economists in our country put it succinctly: "The Fed's policy of keeping interest rates so low for so long means that the real rate (after accounting for inflation) is negative, thereby cutting significantly the real income of those who have saved for retirement over their lifetime." 

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

And, while the desire to goose a struggling economy is understandable, the policy is flawed in so many ways it is hard to capture them all. There is a real risk of inflation in the medium term, which is also bad for savers, entrepreneurs, and our country. At the same time, it creates distortions in the stock market today. Stocks are reacting to the idea that government will be there to artificially inflate. So, in essence, we are fixing a crash from a bubble in the economy by inflating another bubble. In the words of real estate finance expert and Mercatus Scholar Anthony Sanders:

The Fed shocked most with an open-ended purchase program, especially in Fannie and Freddie mortgage-backed securities. It won't help housing because with tight credit, only wealthier Americans with perfect credit benefit from lower mortgage rates. Additionally, seniors get hurt again with aggressive Fed action because bank deposit rates fell. This action will not help the housing market, it will not help unemployment, but it will create bubbles in asset prices.

[ Take the U.S. News Poll: Should the Federal Reserve Engage in a QE3?]

This attempt to revive the economy through QE3 will fail for the same reason that QE1 and QE2 failed: There is no such thing as a free lunch and, to the extent that low growth is driven by non-monetary factors, we systematically erode our capital base by making inflation both high and unpredictable.  

Concern—and in some cases exasperation—with the Fed's most recent action is starting to cross the line into a type of gallows humor regarding creative new definitions for "QE3." Although it actually refers to a third round of quantitative easing, terms such as "Quiet Execution, third season" are making the rounds among uneasy economists. Another favorite, playing on the fact that many of the uninitiated believe QE3 is actually a cruise ship, is simply "Titanic." (Readers are encouraged to offer their own interpretations.)

Why such dire predictions?  As the American Enterprise Institute Scholar Daniel Hanson says, "Bernanke's attack mode means unsterilized expansion of the monetary base in a manner that will anger his international central bank counterparts and put upward pressure on prices in the U.S."  In other words, we are further risking inflation down the road on the theory that dropping mortgage interest rates from 3.55 percent to 3.25 percent (and that, just hoped for, not guaranteed) will somehow jumpstart a sluggish housing market and create more jobs.    

[ Read the U.S. News Debate: Should There Be More Quantitative Easing?]

It is certainly easy to armchair quarterback and the Fed has a difficult job. The bottom line, however, is that it simply has too much unfettered power over too much of the economy for it to continue to act without oversight. As that must-read Wall Street Journal op-ed explained:

The Fed has effectively replaced the entire interbank money market and large segments of other markets with itself. It determines the interest rate by declaring what it will pay on reserve balances at the Fed without regard for the supply and demand of money. By replacing large decentralized markets with centralized control by a few government officials, the Fed is distorting incentives and interfering with price discovery with unintended economic consequences.

(emphasis added)

Anyone who has raised children knows that parenting is an uncomfortable balancing act between encouraging independence and setting boundaries. As freedom is increased, its price tag is living with the consequences of one's actions. At this point, the Fed is acting and we will live with the consequences. In my opinion, they just bought themselves more boundaries.