QE2: Is the Fed “mistaken” on purpose

There is an excellent article on QE2 by Robert Barro (ht Greg Mankiw), I suggest you read it.

However, there is one point – where it goes from descriptive to a little more forward looking about policy – where I might see things in a slightly different shade:

The downside of QE2 is that it intensifies the problems of an exit strategy aimed at avoiding the inflationary consequences of the Fed’s vast monetary expansion. The Fed is over-confident about its ability to manage the exit strategy; in particular, it is wrong to view increases in interest rates paid on reserves as a new and more effective instrument for accomplishing a painless exit.

I see QE2 slightly differently.  QE is partially a means of getting the Fed to commit itself to lower interest rates in the future, by introducing the “loss on bonds” in their objective function.  In essence, the Fed KNOWS that this policy will lead them to overshoot their inflation target.

Now I agree with Barro when he says that, by using different instruments the “future Fed” can reduce the relative losses – but if they have really introduced QE to commit to a lower path of short-term interest rates this is a mute point.

This is the key question for me here – are the Fed using QE as a commitment strategy, or are they just using it as a way to directly increase the money stock or directly push down longer term rates.  Personally, I don’t think the uses are independent and I think that some form of “commitment” is implicit in what they are doing.

  • “Is the Fed “mistaken” on purpose” is really let us think about that, and I think not all of the visits will do that mistake.

  • I think their just increasing the money stock!