Knowledge@Wharton: "The Fed – the Mouse that Roared"

From Knowledge@Wharton:

Federal Reserve chairman Ben S. Bernanke’s speech Friday at the gathering of government and academic economists in Jackson Hole, Wyoming, offered strong new indications that the flailing U.S. economy will likely get new stimulus measures from the Fed.

But the measures being discussed are unlikely to have much effect on the economy, other than to artificially bolster stock and commodity prices to some extent. “I have severe doubts that this kind of monetary policy is likely to be beneficial in the long run,” says Wharton finance professor Franklin Allen, who was at the conference. “It has not been in Japan and they have now been following these kinds of policies for many years…. One of the major talking points at the conference was how little real effect all this monetary stimulus is having.”

One reason for that ineffectiveness, many believe, is that interest rates are already so low – actually negative in some cases after accounting for inflation – that further monetary easing has little impact. It’s like trying to “push on a string,” goes an expression sometimes used to explain the ineffectiveness of easing policies in today’s record-low interest rate environment.

A potential QE3 (a third round of so-called quantitative easing) will be effective, however, at distorting market prices through asset price inflation, Allens adds. “That is part of the problem as to why these actions don’t have too much in the way of real effects. They are hiding what the market is telling people…. The reason the stock market is so high at the moment is at least partly because of these interventions. Similarly with commodity prices…. They are distorting prices and not letting the market do its job.”...MORE