NCPA - National Center for Policy Analysis

Monetary Policy Easing is Nothing to Fear

November 5, 2010

As the storm gathered during 2008, the Federal Reserve aggressively eased monetary policy by using open market operations to drive short-term interest rates to near-zero levels.  The Fed's lending during 2008 together with its asset purchases in frozen markets caused the assets in its balance sheet to increase sharply, from $800 billion before the crisis to over $2.3 trillion by year-end, says Robert McTeer, a distinguished fellow with the National Center for Policy Analysis.

Fed lending and asset purchases on such a massive scale caused equal expansion of its liabilities, most importantly the reserve deposits of commercial banks and thrifts.  The expansion of bank reserves normally would have prompted additional bank lending and investing and thus expansion of monetary deposits.  However, the last step in that process was never taken to any substantial extent.

Indeed, the massive loans and investments made by the Fed did not translated into overly rapid growth in the money supply, says McTeer.

  • Despite the widespread slack in the economy, including an almost 10 percent official unemployment rate, money growth has not been overly rapid for the circumstances.
  • M2, the most reliable measure of money, has grown only 3 percent over the past year, while the narrow M1 measure grew only 6.3 percent.
  • Real gross domestic product (GDP) growth has decelerated recently, to an annual rate of 1.7 percent in the second quarter and 2 percent in the third, with over half of this meager growth attributable to inventories.
  • Unemployment seems stuck at 9.6 percent; if discouraged workers and others marginally attached to the labor force are included, the unofficial unemployment rate exceeds 16 percent.

Moderate money growth, weak real GDP growth, declining total employment and persistently high unemployment have driven inflation down, not up.  Under these circumstances, at least moderate Fed easing is needed, but it should take place routinely and without fanfare.  Obsessing over inflation while it is falling and while deflation is emerging as a possibility is not helpful, says McTeer.

Source: Robert McTeer, "Monetary Policy Easing is Nothing to Fear," November 3, 2010.

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