In responding to the financial crisis, the Federal Reserve has taken on more assets than required to sustain its policy rate, a tactic know as quantitative easing, to prevent a worse recession. But how well do economists and policymakers understand the effects and implications of this action? The channels through which quantitative easing affects the economy are different than traditional monetary policy. Economists do not have models for QE, and traditional policy models do not fit quite right. And having never been in this situation before, we need to understand how the Fed will unwind its balance sheet when the appropriate time comes. QE is a tremendous tool of the Federal Reserve and the path it takes in the near future will have long-ranging implications.
Resident Scholar
Vincent Reinhart |
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I appreciate this opportunity to discuss aspects of quantitative easing with some former central bank colleagues on this panel.
Today's topic is monetary policy in a low interest rate environment. For the Federal Reserve, which will be my main focus, that means quantitative easing because the federal funds rate has already been effectively brought to zero. My presentation today will have three parts. First, I will discuss the channels through which quantitative easing works, because that sets up a basis to evaluate the policy. Second, in what may sound ironic, I will explain why quantitative easing is hard to quantify. That will say something about the ways central banks operate and about the current state of economics and finance. Last, I shall discuss the risks associated with quantitative easing. This will highlight the importance of having an exit strategy. In that regard, this discussion should not be viewed as relevant exclusively to the Federal Reserve. Any central bank confident in its ability to exit might be more willing to enter a period of very low interest rates.
Click here to download the full speech as an Adobe Acrobat PDF.
Vincent Reinhart is a resident scholar at AEI.
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Sunday, November 22, 2009
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