Misconceptions About Fed’s Bond Buying – Bloomberg 09-02-13

Salient to Investors:

Joseph E. Gagnon at the Peterson Institute for Intl Economics writes:

QE still is the right policy.

QE bond purchases are not comparable to stimulus spending on roads and tax cuts, which adds to the national debt. QE is a swap of one asset, bank reserves, for another, bonds, so has no direct effect on the national debt. QE indirectly shrinks the national debt by reducing interest payments and by strengthening economic activity, which raises tax revenue.

QE has a large and long-lasting effect on bond yields, and a positive effect on economic activity. Bond yields are much lower than you would expect given the state of the economy and the large increase in federal debt. The recovery is sluggish because of lasting damage from the bursting of the housing bubble, fiscal contraction at all levels of government and weakness in the rest of the world, especially Europe.

Any policy that supports economic recovery is good for stock prices, and does benefit the wealthy. A more vigorous economic recovery increases employment, which disproportionately benefits the non-wealthy, while lower long-term interest rates benefit borrowers, who tend to be poorer, and harm savers, who tend to be richer.

QE is not disrupting financial markets and does not encouraging risky and wasteful behavior. QE has helped to keep markets liquid and healthy. QE could encourage more risk if markets believed short-term interest rates would remain at almost zero for a long time, but the Fed has been clear that short-term rates will have to rise eventually. Plus the Financial Stability Oversight Council can stop banks and other institutions from engaging in activities that pose a systemic risk, such as taking on excessive leverage.

The Fed in effect controls bank deposit rates, but it has no control over the spread banks charge when they lend, and it is that spread that provides the incentive for bank lending. Fed policy to keep deposit rates low has no effect on the spread.

QE won’t cause high inflation. The lag between Fed policy and its effect on employment and inflation is long.

 Read the full article at  http://www.bloomberg.com/news/2013-09-02/misconceptions-about-fed-s-bond-buying.html

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