It’s looking more and more like another program of quantitative easing (ie, money printing) is on the horizon. Federal Reserve Chairman Ben Bernanke appeared before the Senate Banking, Housing and Urban Affairs Committee on Thursday to discuss economic issues. From Reuters:
Even with interest rates effectively at zero, Bernanke argued there is more the central bank can do if needed to spur growth.
One possibility would be to lower the rate it pays banks to park excess reserves at the Fed, currently 0.25 percent. Asked by a legislator why the Fed continues to pay banks to keep their money idle despite weak lending conditions, Bernanke said cutting the rate carries risks.
“If rates go to zero there will be no incentive for buying and selling federal funds, overnight money in the banking system and if that market shuts down … it’ll be more difficult to manage short-term interest rates,” Bernanke said.
Other options for the Fed include bolstering its stated commitment to keep official rates low for an “extended period,” or purchase yet more debt, Bernanke said.
By “purchase yet more debt”, Bernanke means he may engage in another round of quantitative easing, which is Fed-speak for creating money from thin air. Wikipedia has a good explanation of quantitative easing:
The term quantitative easing (QE) describes a form of monetary policy used to increase the supply of money in an economy when the bank interest rate, discount rate and/or interbank interest rate (such as the Federal Funds Rate or overnight rate) is either at, or close to, zero (a situation known as zero interest rate policy).[citation needed] The central bank purchases financial assets, including government paper and corporate bonds, from banks and other financial institutions using money it has created ex nihilo (Out of Nothing).[1]
The fact that the Fed is considering implementing anther QE program is troublesome because the injection of large amounts of new money into the economy can lead to high price inflation down the line once the economy begins to recover. In other words, the prices for goods and services we buy everyday could increase substantially, if not catastrophically as a result of massive amounts of new money being injected into the economy. The Fed has already created a enormous amount of new money to combat the financial crisis, but much of it remains “in hiding” because banks are reluctant to lend it. As the economy recovers and and the money in hiding begins to circulate, it will place greater demand on goods and services and push up prices. The Fed’s balance sheet at the beginning of 2008 was around $500 billion, but thanks to the financial crisis and shaky economy, it has ballooned to over $2.3 trillion today as a result of previous QE and lending programs. How much more money will it create in the next round of quantitative easing? Two trillion? Five? Even more than that? The more it creates, the more it will have to drain later to avoid massive price inflation once economic recovery finally takes hold. I, for one, lack confidence the Fed will be able to time the draining of liquidity and do enough of it to prevent significant price inflation down the road.
-CH
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