A New Normal for Monetary Policy?

A year and a half ago when the Fed’s extraordinary quantitative easing (QE) was shifting from emergency liquidity programs to large scale asset purchases, we convened a conference at Stanford’s Hoover Institution to discuss the shift. Jim Hamilton, of UC San Diego, in his talk Concerns about the Fed's New Balance Sheet and Peter Fisher of Blackrock in his talk The Market View expressed serious concerns about the extraordinary policies and the use of the Fed’s balance sheet to finance them. Don Kohn, then Fed Vice-Chair, attended and defended the Fed’s position

One concern expressed at the time (March 2009) was that such extraordinary measures would become a "new normal" for monetary policy, in which the Fed would not restrict its massive doses of QE to times of panics and other emergencies. Such a new normal would likely breed uncertainty and reduce the Fed’s independence, eventually leading to economic instability and inflation. I put it this way in my paper in the book, Road Ahead for the Fed, which came out of the conference:

“The danger I see is that as the recovery begins, or after we are a couple of years into it, people may feel that it’s not fast enough, or there is an unpleasant pause. Either could generate heavy pressure on the Fed to intervene…. Why would such interventions only take place in times of crisis? Why wouldn’t future Fed officials use them to try to make economic expansions stronger or to assist certain sectors and industries for other reasons?”

Many Fed officials dismissed the concerns about such a scenario, saying that the crisis was unique. Yet this is exactly the scenario that is now playing out. Sure enough, the recovery paused, and lo and behold, there is a QE2 in the works.

Today’s Roubini Global Economics newsletter is ominous. It predicts that after QE2 the Fed will “announce QE3 (and eventually even QE4).” After Road Ahead for the Fed we published another book Ending Government Bailouts as We Know Them. Perhaps the title of the first book should have been The End of Monetary Policy as We Know It