A LOT has been written recently, pro and con, about the Fed’s new round of quantitative easing, dubbed QE2. But, frankly, much of the discussion on both sides lacks a coherent analytical framework for thinking about the key issues. I try here to provide such a framework.
The Fed, personified by its chairman, Ben Bernanke, is concerned about the weak economic recovery and, particularly, by the possibility of future deflation. To counter this tendency, the Fed plans a new round of monetary expansion. The main conclusions that I reach are:
- In the present environment, where short-term nominal interest rates are essentially zero, expansionary open-market operations involving Treasury bills would do nothing (a point with which the Fed concurs).
- Expansionary open-market operations featuring long-term Treasury bonds (QE2) might be expansionary. However, this operation is equivalent to the Treasury shortening the maturity of its outstanding debt. It is unclear why the Fed, rather than the Treasury, should be in the debt-maturity business.