It is no secret that economists Tyler Cowen and Paul Krugman have profound differences on the proper role of how government should manage the economy. Over the course of the ongoing economic crisis, they've engaged in an enlightening debate about such topics as the effectiveness of Keynesian fiscal stimulus policies via their respective blogs and New York Times columns. The libertarian-minded Cowen is a fiscal stimulus skeptic; Krugman, notoriously, is not.
So when the two men both greeted, with muted support, the surprise news that the Federal Reserve planned to engage in an aggressive strategy of "quantitative easing" to loosen up the credit crunch, you had to take notice. The Fed announced on Wednesday that it will buy $1.2 trillion worth of U.S. Treasuries and other bonds, in an effort "to provide greater support to mortgage lending and housing markets," and "to help improve conditions in private credit markets."
Freshly returned from a trip to Europe, Krugman called it a "good move." Cowen, meanwhile, noted "that this should have been our first move," because "it is more likely to work" than fiscal stimulus.
Other economists chimed in with their own support. But their very unanimity could be a cause for some dismay. Quantitative easing is a fancy way of saying "turned on the printing press." The expansion, out of thin air, of the Federal Reserve's balance sheet by $1.2 trillion is a sobering acknowledgment that Ben Bernanke believes the Fed needs to make the strongest possible moves to prevent an accelerating economic disaster. Everyone knows: There is a clear cost to massive quantitative easing. If you pump another trillion dollars into the money supply, the value of the dollar will fall. Inflation, long term, will rise. Since one of the Fed's most awesome responsibilities is to fight inflation, that alone tells you how nervous Bernanke must be.
It's like when your grammar school started having Fallout Drills. On the one hand, it's nice that they're planning, but on the other hand ... why bother finishing that math homework? What do they know that we don't?
Or as the Wall Street Journal's Brett Arends wrote:
It is hardly a confident sign when one of the few big customers left for US government paper is the US government. It smacks of a bar that starts to sell a lot of booze to the owner. On credit.
There's been some chatter in the blogosphere that the move was made to keep China happy. Last week, China's prime minister, Wen Jiabao, expressed concern about the value of China's investment in U.S. bonds. A few days later, the Federal Reserve announces massive purchases of U.S. bonds, thus boosting their price and presumably making China more comfortable. But economist and former Treasury official Brad Setser does a pretty convincing job of shooting down that theory. Higher bond prices might be good for China, but a lower dollar is not -- it makes Chinese exports less competitive. China, ultimately, wins for the same reason the U.S. and the rest of the world will win -- through a resumption of financial stability. We're all in the same boat, on this voyage.
If I seem like I'm intent on beating this theme into the ground this week, that's because I am. I, personally, would rather Tim Geithner and the rest of Obama's economic team were spending every available second figuring out their plan to stabilize the financial system, rather than answering questions about exactly when they learned that AIG was handing out millions of retention bonuses to its derivatives traders. The Fed's momentous action this week is just the latest demonstration that we have in no way seen our way clear to a resolution of the financial crisis. The Fed's decision is by far the biggest story of the week, even if it hasn't merited one-tenth of 1 percent of the press coverage and popular attention devoted to the AIG bonus scandal. But if the bonus scandal dissuades Congress from giving the administration the backup it needs to support the Fed's actions with decisive moves of its own, that will be the biggest scandal of all.
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