The economics faculty ward here at Miskatonic University is getting crowded. Just saying. Tim Duy:
Gramm and Taylor Don't Get It: As a general rule, I stay clear of the Wall Street Journal editorial pages…. I just don't have the emotional energy for it anymore. But Brad DeLong forced it on all of us….
Gramm and Taylor don't seem to realize that the stock of Treasuries is the same regardless of who owns them. What GT see as higher future interest rates would simply be higher current interest rates if the Fed was not temporarily substituting some cash for bonds…. Yet there is still room to build upon DeLong's critique. GT get off to a bad start:
>>That kind of monetary expansion would normally be a harbinger of inflation. However… the inflation rate has stayed close to the Fed's 2% target…. Inflation is not, however, the only cost of these unconventional monetary interventions.
Notice that they admit that inflation has remained under control, yet then proceed to claim that inflation is a cost of QE. How can inflation be both under control and a cost? It can't, of course; GT just can't admit that inflation is not a problem even after actually admitted that fact. GT continue:
As investors try to predict the timing and effect of Fed policy on financial markets and the economy, monetary policy adds to the climate of economic uncertainty and stasis already caused by current fiscal policy.
QE3 actually reduces the uncertainty about monetary policy. Rather than defining QE by arbitrary amounts and end dates, we now have a steady flow of QE tied only to improving economics conditions in the context of price stability. No more uncertainty that the Fed will pull policy support regardless of the state of the economy….
Bottom Line: If the US economy was not operating at the zero bound, the Federal Reserve would react to improving economic conditions and tighten policy by selling Treasury securities in the process of targeting a higher Federal Funds rates. John Taylor should know this. Now, with quantitative easing, if economic conditions improve, the Fed will tighten policy by… yes, the same thing, selling Treasury securities. In either case, the Fed will only do this if interest rates are already responding to stronger activity. In this light, the Fed isn't really doing anything new. I don't think you should fear the Fed having to withdraw the stimulus. Indeed, I think you should really fear the opposite - that the economy does not lift off the zero bound before the next recession hits. If that happens, we will all be wishing the Fed had done more, and sooner.