Monday, November 24, 2008

The U.S. "has a technology called a printing press"

So I'm working hard on meeting my deadlines for the upcoming University of Arizona Free Personal Finance site and course, as well as an unusually large teaching load, running our business, etc., etc., and the Wall Street Journals are piling up. So I decide to take a break and go through them. In the Tuesday, November 18th Money and Investing section, I run into something very interesting:

In his famous address on fighting deflation in 2002, Mr. Bernanke said the Fed wouldn't run out of ammunition to influence prices, even after cutting interest rates to zero: "The U.S. government has a technology, called a printing press ...that allows it to produce as many U.S. dollars as it wishes at essentially no cost,"

Ok, so why have we not used that printing press a lot more? William Buiter of the London School of Economics wrote on Saturday that the Fed had doubled its balance sheet since the crisis started. This means that the Fed has printed up (or the electronic equivalent) a great deal of money, and used it to pay for the purchase of U.S. government bonds and other financial assets. But with the economy nonetheless on the brink of deflation and a severe recession or depression, why doesn't the Fed print a lot more?

The risk of future inflation is far less of a danger right now than the risk of deflation and depression, plus the Fed has tools that can combat any future inflation quickly and effectively. Very short term rates are close to zero, but medium and long term rates are far from zero, and the evidence is strong that if the Fed printed a massive amount of money to buy up those securities, and thus down their real interest rates, it would be a great stimulus.

So why isn't the Fed doing these open market purchases on a much greater scale (as opposed to discount rate cuts which are about exhausted)? Unfortunately, we can't have a massive and intelligent fiscal stimulus for another two months when the Democrats take power, but Bernanke can act in a strong way now with massive open market purchases (which would also lower the interest the government pays on its fiscal stimulus, and thus decrease inhibitions about spending due to the deficits). Why isn't he? This is an important question that is not discussed enough in the economics/finance/politics blogosphere.