Other governments, and their central banks, have reacted vocally and negatively to the Federal Reserve’s plan for another round of quantitative easing-which means that the Fed purchases long-term bonds. These negative reactions to QE2 outside the United States are presumably motivated by their self-interest, but I believe that another large-scale Fed purchase of bonds is also against American interests.
One justification frequently given for further Fed open market operations is that it will increase bank lending through raising bank reserves (“high powered” money). The reluctance of banks to lend has clearly been a factor in the slow down in the US recovery. Yet the Fed’s creation during the past couple of years of well over trillion dollars in additional reserves through open market operations has not induced rapid increases in bank lending. Instead, banks have accumulated huge amounts of excess reserves; that is, reserves above the amount they are required to keep as collateral for their deposit liabilities.
Given that banks already are holding such large reserves that carry low interest rates, it is hard to see why creating additional reserves will stimulate much additional lending. The big constraint in the lending market is that both borrowers and lenders perceive considerable risk to investments. This is partly due to government policies, like the health care and the financial reform bills, and proposals to raise taxes on higher incomes and on capital gains that will raise costs of doing business, and lower after-tax incomes of investors. Perhaps that perception will change due to the recent election of many Congressmen who say they want to lower taxes and reduce the size of government, but this perception of a risky investment environment will not change because the Fed creates large quantities of additional reserves.
(photo credit: Wikipedia)