QE2 Could and Should Work, Says McTeer

Nov 19, 2010, 12:46 ET from National Center for Policy Analysis

Former Fed Maverick:  All Things Considered, Potential Benefits Outweigh Risks

DALLAS, Nov. 19, 2010 /PRNewswire-USNewswire/ -- Despite potential risks, the Federal Reserve's plans to buy $600 billion in U.S. Treasury bonds by June of next year will expand the money supply and should stimulate the economy, according to National Center for Policy Analysis Distinguished Fellow Bob McTeer.

Dr. McTeer's new analysis of the impact of Fed's controversial bond buying policy was released today by the NCPA.

"Banks aren't exactly hoarding cash, but they're not lending enough either," said Dr. McTeer, who when he was a member of the Federal Open Market Committee (FOMC) was never shy about disagreeing with the Fed's monetary policy.  "That's because holding extra cash reserves has been prudent during these turbulent times.  By providing more reserves through the purchase of Treasuries, however, there will be fewer benefits to holding additional cash and it will increasingly be in bankers' interest to put their excess reserves to work through loans and investments."

McTeer acknowledged that the magnitude of quantitative easing—$600 billion by June 2011—is "large but all of it may not be needed." He said that the growth of the money supply has been slow given the circumstances and said that QE2 is much like the "surge" of more troops in Iraq. The troops already there were essential, but not quite sufficient to get the job done soon.  Similarly, previous Fed efforts have been essential, but more was needed.

"The fear, of course, is inflation," McTeer warned, "some measures of inflation are below one percent and there is a great deal of slack in the economy; capacity utilization is low and unemployment is high.  So the Fed believes that under these conditions it can stimulate growth in the money supply without a high risk of inflation.  And I agree with that."

Another concern about quantitative easing is that it could depreciate U.S. currency on foreign exchange markets.  McTeer said that the ultimate effect on the dollar is uncertain. "More dollars created might depress it in foreign exchange markets but, if the monetary surge works, a healthier U.S. economy might strengthen it. In any case, flexible exchange rates are intended to reconcile whatever domestic policies are appropriate for domestic conditions with the rest of the world. Internal policies may have external circumstances, but charges that the intent is to spur the domestic economy through currency depreciation are way off base," he said.

"When evaluating QE2 we need to remember that despite genuine concerns, the economic and financial ills we face today are strikingly similar, in nature if not magnitude, to the Great Depression, and the Fed 'mopped up' reserves then, causing banks to lend even less," McTeer added.  "We need to remember that now."

Bob McTeer is a Distinguished Fellow at the National Center for Policy Analysis.  Dr. McTeer is a former member of the Federal Open Market Committee (FOMC) and served 14 years as President of the Federal Reserve Bank of Dallas.  His Economic Policy Blog offers insight on issues of economic growth, taxes and monetary policy.

The National Center for Policy Analysis (NCPA) is a nonprofit, nonpartisan public policy research organization, established in 1983. The NCPA's goal is to develop and promote private alternatives to government regulation and control, solving problems by relying on the strength of the competitive, entrepreneurial private sector. Topics include reforms in health care; Medicare and Social Security; retirement; taxes; small business policy; and energy and environmental regulation.

SOURCE National Center for Policy Analysis