The Corner

There Is Nothing in QE2 Worth Conserving

David Beckworth has offered a thoughtful, but I believe ultimately flawed, “conservative case” for the Federal Reserve’s latest round of quantitative easing. While I wholeheartedly share Professor Beckworth’s desire to see the economy improve, and share his concerns that if it does not we may end up with expanded government spending, it is hard to see QE2 as providing the environment of certainty the private sector needs in order to expand.

Professor Beckworth should be commended for clearly spelling out his assumptions. Public debate would be far more fruitful if others did the same. Let’s start with his core assumption: Because the monetary base has been expanding and there’s been little inflation and little increase in consumption, households must be hoarding money. The logic in this case is sound; I disagree with the facts.

First, the good professor argues that spending is far below trend. That is true enough as it goes, but this trend includes a massive housing bubble, where imaginary wealth fueled spending, aided by massive borrowing from abroad. The objective of our economic policies should not be to get back to the top of the previous bubble. It was this desire to replace the lost wealth of the dot-com crash that contributed to the Fed’s juicing of the housing market. All that said, consumption today is higher than at any time during the recent bubble. The primary problem facing our economy is not a lack of demand.

Like Ben Bernanke, Beckworth believes we have had no inflation. Again like the Fed, he arrives at this conclusion by subtracting out of the inflation numbers all the things that real people spend their money on, such as food and energy. I would not claim we are facing hyper-inflation, but two facts should be borne in mind. First, over time even low levels of inflation erode away wealth; and second, a large surge of inflation is likely to occur quite suddenly, without giving the Fed months or years of warning.

Finally, the good professor fails to consider that households may not be “hoarding” cash by choice. After all, most of us still have our cash in banks, even if in transaction accounts. The money hasn’t been stuffed under the mattress. In fact, throughout this recession and financial crisis, the amount of insured deposits has been consistently increasing. We are nowhere near a 1930s style disintermediation of the banking sector, which greatly contributed to an actual decline in the money supply during the Great Depression. Most market participants, me included, would be happy to put their money into valuable investments. Yet with interest rates near zero, there’s little incentive not to hold cash balances, as the opportunity costs are nonexistent.

If Beckworth wants to preach “conservative” values and principles, he might start with the observation that it is savings and work that provide wealth, and reject the Keynesian notions that we can spend or debase our way to prosperity.

Mark A. Calabria is director of financial-regulation studies at the Cato Institute.

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