Greg Mankiw on QE2

Greg Mankiw's Blog: QE2

Mankiw is a professor at Harvard, author of the leading college economics textbook, and served as member of Bush's economic advisors.

Several people have asked my opinion of the Federal Reserve's new round of quantitative easing.  In particular, some have noted that I did not sign the open letter by conservative economists critical of recent Fed actions.

My view is that QE2 is a modestly good idea.  I say it is a "good idea" because, like Ben Bernanke, I am more worried at the moment about Japanese-style deflation and stagnation than I am about excessive inflation.  By lowering long-term real interest rates below where they otherwise would be, QE2 should help expand aggregate demand.  I include the modifier "modestly" because I don't expect these actions to have a very large effect.

Moreover, I do see some potential downsides.  In particular, the Fed is making its portfolio riskier.  By borrowing short and investing long, the Fed is in some ways becoming the hedge fund of last resort.  If future events require higher interest rates, the Fed will end up making losses on its portfolio.  And even if doesn't recognize these losses (by not marking to market), it could end up paying more interest on newly expanded reserves than it is earning on its newly acquired portfolio of long bonds.  Such a cash-flow deficit could potentially undermine the Fed's political independence (which is already not very popular in some circles).  Yet if the Fed tries to avoid these losses by failing to raise rates when needed, inflation could indeed become a problem down the road.  I trust the team at the Fed enough to think they will avoid that mistake.

So, in the end, I judge QE2 to be a small but risky step in the right direction.

This pretty much sums up my take, although he may a shade more optimistic than I am. The "hedge fund of last resort" analogy is great good way to put it.

 

Comments

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QE is intended to devalue the dollar. Given the zombie households and banks in the US, QE is going to be mildly deflationary in the US, and it is going to cause US investors to invest their money in developing countries in search of higher returns, causing higher inflation in developing countries. Higher inflation in the developing world than in the US devalues the US dollar.

Devaluing the US dollar or protectionism are the only way the US can deleverage. Bernanke knows this.