Following yesterday’s meeting, the Fed’s Federal Open Market Committee seems to be relatively optimistic that (1) the recovery is underway (even if employment figures are less than one might hope) and (2) despite rising commodity prices, inflation expectations “remain stable.” As a result, some are predicting that the Fed will not continue quantitative easing past June. Perhaps $600 billion in bond purchases will be enough. See report here and Marc Faber’s far more skeptical prediction here.
Things seem far more complicated, however, and the long-term implications of current and past policy decisions may be rather significant. Consider the question of inflation. As Kelly Evans (WSJ) argues, there is, in fact, evidence that inflationary expectations are growing:
Americans are increasingly worried about the rising cost of living. And who can blame them? The cost of food and fuel, two of the most vital and visible household purchases, has jumped in the past year; gasoline prices in particular have spiked. In turn, consumers polled this month by Reuters and the University of Michigan expect inflation of 4.6% on average over the next year. That is more than double the 2.2% expected in September, when double-dip fears raged. It is also well above the actual inflation rate.
One might expect that a little inflation is a good thing. If consumers expect prices to fall—if they assume a “deflationary mindset”–they may defer purchases until the future, sucking the wind out of an already anemic recovery. Yet, as Evans observes: “Consumers may fear inflation…but are reacting in a deflationary way” (e.g., by reducing discretionary spending in response to increases in fuel costs).
If this is correct, now that the Fed has assumed responsibility for the unemployment rate, will it be able to resist further quantitative easing? And if inflationary expectations translate into higher levels of inflation, what will be the consequences for policy and politics? In short, will another round of quantitative easing be followed by quantitative tightening?
As Irwin Kellner (Marketwatch) explains:
If the central bank decides that the time is fast approaching to take a stand against inflation, it will have to deprive inflation of its fuel — money. Reducing the money supply will cause interest rates to rise, thus cutting into spending and borrowing. This will result in layoffs, thus boosting the already-swollen ranks of the jobless.
Veronique de Rugy (Mercatus Center) has examined the impact of interest rate assumptions on the costs of servicing the national debt. If interest rates return to the levels of the 1980s, “our interest payments would nearly triple from CBO’s projection of $749 billion to $2.0 trillion. Accumulated interest payments over this period would double from their current projected level of $5.7 trillion dollars to $11.0 trillion dollars.” She illustrates the impact with the following chart:
Of more immediate concern to the Left may be the short-term political implications for the 2012 elections. In the words of Mark Tapscott (San Francisco Examiner):
Here’s a political equation that ought to furrow the brows of everybody working to get a second term for President Obama: QE1+QT1=DEFEAT.
The Fed giveth and the Fed taketh away. Unfortunately, it increasingly executes its duties without clear rules to constrain its discretionary authority.
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