## Yes, John Taylor and Phil Gramm Have Written a Column About the Federal Reserve and QE III That Sharply Reduces My Utility. I Blame Miles Kimball

The smart and public-spirited Miles Kimball asks the Romney economic advisors to explain themselves:

I really wish he had not done this, for I find the results very painful indeed.

You see, John Taylor, with the assistance of Phil Gramm, carries out the assignment.

And I feel as though I have been sentenced to the Agonizer:

Gramm and Taylor's argument, in a nutshell, is that it is bad for the Fed to buy bonds now through Quantitative Easing III because:

1. The Fed will eventually have to sell its bonds--say in 2016.
2. When it sells the bonds in 2016 private investors will have to increase their bond holdings quickly.
3. Thus interest rates will rise in 2016.
4. And high interest rates in 2016 will be a bad thing.

But suppose the Fed did not buy bonds now through QE III and thus did not sell them in 2016. Then in 2016 the supply of bonds for private investors to hold would be exactly the same. Thus bond interest rates in 2016 would be exactly the same (unless something automagically happened to change demand for bonds).

The lesson:

• QE III unwound in 2016 produces more liquidity and lower rates for the next four years.
• QE III unwound in 2016 leaves us with the same interest rates in and after 2016.

So why are Taylor and Gramm arguing that returning interest rates in 2016 and after to what they would have been anyway is a cost to QE III? It's a zero. It's not a change. It simply does not compute.

ERROR. ERROR. ERROR. ERROR. ERROR

Phil Gramm and John Taylor:

The Hidden Costs of Monetary Easing: Since mid-September of 2008, the Federal Reserve balance sheet has grown to $2,814 billion from$924 billion…. That kind of monetary expansion would normally be a harbinger of inflation. However, with banks holding excess reserves rather than lending them out—and with velocity (the rate at which money turns over generating national income) at a 50-year low and falling—the inflation rate has stayed close to the Fed's 2% target…. Inflation is not, however, the only cost of these unconventional monetary interventions…. There will be even greater costs when the economy begins to grow and the Fed, to prevent inflation, has to reverse course and sell bonds and securities to the public….

Selling a trillion dollars of Treasury bonds on the market—at the same time the government is running trillion-dollar annual deficits—will drive up interest rates, crowd out private-sector borrowers and impede the recovery…. The same problems will occur as the Fed begins to sell its holdings of mortgage-backed securities…. When the Fed bought these securities, it may have marginally reduced mortgage interest rates. Selling them during a real recovery will likely cause mortgage rates to rise….

Rational decision making comes down to a comprehensive measure of cost and benefits. The Fed's effort to use monetary policy to overcome bad fiscal and regulatory policy long ago reached the point of diminishing returns. The benefits of a third round of quantitative easing will almost certainly be de minimis. But when economic growth does return, Fed actions will have to be reversed in an era of rising interest rates, and the marginal cost of a QE3 tomorrow will almost certainly be far greater than the marginal benefit today.

Someday, hopefully next year, the American economy will come back to life. Banks will begin to lend, the money supply will expand, and the velocity of money will rise. Unless the Fed responds by reducing its balance sheet, inflationary pressures will build rapidly. At that point the cost of our current monetary policy will be all too clear. Like Mr. Obama's stimulus policy, Mr. Bernanke's monetary expansion will ultimately have to be paid for.