Quantitative Easing, Qualified Unease

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Welcome to Politics Bites, where every afternoon at It's a Free Country we bring you the unmissable quotes form the morning's political conversations on WNYC. This morning on The Brian Lehrer Show, Jon Hilsenrath, chief economics correspondent for the Wall Street Journal, talkedabout Federal Reserve policy regarding quantitative easing, its effects on inflation, and why the Fed remains optimistic about economic recovery.

The fight over extending the Bush tax cuts—and the controversial $800 billion compromise that followed—has held a monopoly on the news cycle for most of December. Somewhat lost in the shuffle was another sort of economic "stimulus" spending proposal: Quantitative Easing, or QE2.

This one's a doozy, so you might want to watch these helpful videos if QE2 is Greek to you.

Quantitative Easing is the Federal Reserve's plan to buy up $600 billion worth of US government bonds with the purpose of driving interest rates down, thus spurring businesses to borrow more money and create jobs. Together with the tax cut extension, that's $1.4 trillion dollars in spending on fiscal and monetary policies aimed at driving economic growth. Jon Hilsenrath said that's much more than anyone was predicting we'd get earlier this year.

I think a lot of people were blindsided by the agreement Obama worked out with Congressional Republicans to not only extend the Bush tax cuts but to add on with payroll tax cuts and some business tax cuts, so I think we ended up getting more stimulus than most people would have bet for in the summer. There’s a question of whether that’s a good or a bad thing.

Here's a prime example of why economics is referred to as "The Dismal Science." New policies tend to raise more questions than they answer, and it's likely there will never be a true consensus on what will succeed and what will fail. In this case, there's confusion over the effect this round of Quantitative Easing has had on interest rates, as they aren't exactly dropping like the Fed meant them to.

Bernanke said he wanted interest rates to go lower, they’re actually going higher…One could argue that it did reduce interest rates, but it actually did it before the program was even implemented…After the announcement happened, they turned around and started rising. There’s a question of why that’s the case. 

So, why is that the case? Hilsenrath offered two possible explanations. The first is an improved economic outlook for 2011. Improved economic outlooks usually lead to higher interest rates, as lending is expected to increase in a growing economy regardless of more unattractive rates. The second was the passage of the tax cut compromise, which added to long-term deficit worries and has driven interest rates up half a percent since the deal was struck.

As far as a bottom line, there isn't much of one.

I think it's fair to say that the Fed's program did provide some stimulus, but I think you can have a lot of debate and disagreement about whether it was fleeting and just how much it helped.

One of the arguments against pursuing the Fed's plan is that we don't need it. One caller who ran a business said that the tax cut extension was enough for him, as it would drive sales and allow him to give his employees a raise. He brought up worries that Quantitative Easing causing inflation, an unintended result of an unnecessary measure. Hilsenrath responded that there were two economic "crosscurrents" that would probably nullify such a scenario.

On the one hand, you have strong demand globally in emerging markets, where growth really has picked up. On the other hand, the economy is burdened by a lot of slack, high unemployment, houses and factories empty…all of that pulls inflation in the other direction. I think we're likely to see these courses fighting to a standstill and not creating a lot of underlying inflation.

As far as how sound the policy is, much remains to be seen. While it's far too early to rule out success, Hilsenrath argued that there are other, more surefire proposals to getting the economy back on track. Unfortunately, nobody's talking about them on Capitol Hill.

I think that what doesn't get enough credit in Washington is that if they came up with a long term deficit reduction plan, something likely to work through the economy over the next 10 or 20 years, it would actually provide stimulus right now today. The bond market would react, long term interest rates would come down, and you’d get more borrowing in the present if people saw a credible path out of the severe fiscal mess that we’re heading into. I’m surprised that policymakers don’t frame deficit reduction as a form of stimulus, because it would be.