Fed defends against QE2 criticismsby Tim Manni
New York Fed President Bill Dudley gave an interview recently with CNBC in which he defended some of the most common criticisms of the Fed’s QE2 program.
Criticism #1: Quantitative Easing will cause inflation:
Dudley contended that new tools the Fed has put in place to withdraw excess cash from the banking system when the economy rebounds would head off inflation, including paying higher interest rates on the excess reserves banks are now holding. “We are very confident of our ability to exit when the time comes, in terms of the tools. We also are very confident of our will to exit,” Dudley said.
Criticism #2: All the Fed is doing is “printing money”:
“What we’re doing is, when we buy Treasury securities, we are increasing the amount of reserves in the banking system. For those reserves to actually create money, the banks actually have to lend those reserves out.
Criticism #3: QE2 won’t have “a huge powerful effect on the U.S. economy.” Dudley actually agreed with that critique:
“But even a little bit of nudge to the economy today I think is very, very important because if the economy can grow a little bit faster, that gives you a much better prospect about being in a virtuous circle: a little bit stronger growth leads to a little bit more demand. A little bit more demand leads to more employment growth, higher income and rising confidence… rather than on the other side of things where we’ve seen Japan over the last 15 or 20 years.”
Here’s our question: Will QE2 lower interest rates? The 30-year Conforming ended today at 4.54 percent, up from 4.50 percent yesterday, and 4.35 percent last Tuesday. The 10-yr Treasury actually fell to 2.84 percent today, from 2.92 percent yesterday.
As the Fed’s QE2 program continues to ramp up, we’ll get a better sense of whether or not it’s accomplishing its goals and whether it’s silencing its critics. The economy did enjoy some good news today which came in the form of a positive retail sales report. As we’ve noted many times, a steadily improving economy will firm up mortgage rates naturally. While the Fed’s program is anything but natural, we’ll continue to monitor to see if Treasury yields will drop as planned, and if Mr. Dudley’s defenses are accurate.