The High Cost of the Fed's Cheap Money

March 6, 2012

During the past three years, the Federal Reserve has tripled the size of its balance sheet -- in effect printing $2 trillion -- something it had never done in its nearly 100-year history.  The Fed has lowered short-term interest rates to zero and signaled that it will keep them at that level for years.  Inflation-adjusted short-term rates, or real rates, have been in the minus 2 percent range during the past couple of years for the first time since the 1970s.  Unfortunately, there is no free lunch.  After the Fed's loose monetary policy helped spur the boom-bust in housing, it is remarkable how little attention has been devoted to exploring the costs of Fed policy, says Andy Laperriere, a senior managing director in the Washington office of ISI Group.

A few critics of quantitative easing (QE) and the zero interest rate (ZIRP) have correctly pointed out that these policies weaken the dollar and thereby reduce the purchasing power of American paychecks.

  • They increase the risk of future inflation, obscure the true cost of the unsustainable fiscal policy the federal government is running, and transfer wealth from savers to debtors.
  • But QE and ZIRP also reduce long-term economic growth by punishing savers, reducing saving and investment over the long run.
  • They encourage the misallocation of resources that at a minimum is preventing the natural rebalancing of our economy and could sow the seeds of another painful boom-bust.

Defenders of QE and ZIRP would say that rather than borrowing economic growth from the future, these policies merely smooth the economic cycle and reduce the economic dislocation associated with deep recessions or weak recoveries.  Of course, that was the rationale for the exceptionally low rates during the 2002-2004 period, which, like today, were specifically aimed at depressing saving and encouraging consumption.  Rather than smooth the economic cycle, that strategy helped create a historic boom-bust.

There is no doubt the Fed is doing what it believes is best.  But in addition to the risk of inflation inherent in QE and ZIRP, which Chairman Ben Bernanke has said he is 100 percent confident he can prevent, Fed officials are dismissive of the notion that there are significant costs or trade-offs associated with the policy they are pursuing.

Source: Andy Laperriere, "The High Cost of the Fed's Cheap Money," Wall Street Journal, March 5, 2012.

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