Additional Large-Scale Asset Purchases
This policy decision that was made November 3rd has been popularly called "QE2," or quantitative easing second round. Actually we prefer the use of the term "large-scale asset purchases" because quantitative easing is generally known at a technical level to be trying to influence the economy through bank reserves (bank reserves held at the central bank) and through increasing the quantity of those reserves.
So we are buying Treasury bills and notes, principally Treasury notes, and injecting that into the system with the expectation that there might be some lowering of longer-term interest rates to stimulate the economy and some improvement in asset prices to increase the sense of wealth in the economy and encourage people to consume and businesses to invest.
The intent of the policy is really to support the recovery, to accelerate the achievement of the Fed's two principal mandates—and that is maximum employment along with price stability—and to, in general, improve financial conditions to try to ensure that the recovery continues and, in fact, the recovery picks up steam.
I think it's very important that the public understands that this policy is conditional on how the economy develops in the future. It is conceivable, although I don't expect it, that the policy might be shifted during the eight-month period in which we expect implementation. But certainly it's likely that eventually there will be a reversal of the policy based on improving economic conditions.
Monetizing the Federal Debt
You would normally think of monetization as something that's pretty fixed and permanent, whereas this policy is very reversible and is likely to be reversed at some stage in the future. And I see that decision as being quite independent of fiscal considerations. So if you were going to lay on the Fed the accusation of monetization, you'd also have to acknowledge that in the future there would be demonetization going on when we reverse the purchases and start to sell them back into the market, sell the securities back into the market.
The policy is not focused on either the direction or the absolute level of the value of the dollar.
There has been some downward pressure on the dollar, both during the period in which the markets were anticipating the policy decision of November 3rd and in the aftermath of that decision. There has also been some dollar appreciation recently. But the key point is the purpose of the policy is not dollar devaluation. The purpose of the policy is to improve the U.S. economy, which I think is in the world's interest.
Right now there is no inflation in sight, and I think the risk of hyperinflation is farfetched. At the moment what we're really trying to do is increase the inflation rate from a level that is too low—that is, let's say, at least has some potential of tipping over into disinflation in a deflationary environment.Â Â Â Â Â
Certainly, if we see evidence that inflation is picking up beyond the level that we would consider to be desirable and we see inflation expectations exceeding what we would consider to be healthy, we have the tools to reverse this particular decision and the tools to exit the easing that we've done in the past in 2008 and 2009. And those tools are at the ready, so I'm confident that we'll be able to manage inflation should inflation beyond what we're desiring actually develop.
Effect of Large-Scale Asset Purchases
There are, I would say, three or four principal channels through which the large-scale asset purchases will actually have, we hope, some affect on the economy. The first of those would be asset prices. And monetary policy is always transmitted through changes in relative asset prices, and here we would be looking at asset prices of debt securities, equities, and conceivably other assets in our economy. So that would be one influence. The second would be some influence on longer-term interest rates. Obviously, since short-term rates are at zero level or close to the zero level, at least the policy rate that we normally affect—the federal funds target, federal funds rate target—we're talking, obviously we're talking about longer-term interest rates. And I think it's possible that the policy will have some influence on long-term rates, and those rates will in turn stimulate people to borrow and spend on investment or spend on consumption incrementally more than would have happened in the absence of this policy. A third channel is expectations, influencing expectations about the future of the economy and the potential for the economy to pick up steam and growth to accelerate. And the final, I would not deny, would be through the exchange rate, through the value of the dollar, having some influence on net exports. All of those are potential channels through which this policy can have some positive affect.
I think we need to be measured about our expectations regarding what the policy is likely to achieve. Speaking for myself, I viewed it as a precautionary tool to deal with the potential of deflation and the potential of downsides more than something that was actually going to substantially improve the economy as a policy in and of itself.