Easy Money Getting Complicated

US Federal Reserve Building

Economists are wrestling with the issue of “easy money,” the Federal Reserve’s policy of increasing the money supply and pushing down short-term interest rates. Easy money has helped steer the US into a fragile but sustained recovery, but the policy is also fueling concern that, longer term, all of this “free” money could lead to crippling inflation.


Fed Chairman Ben Bernanke’s repeated public pronouncements on America’s weak job and housing markets suggest that he could be willing to inject more money into the US economy, possibly even unleashing a third round of quantitative easing. Quantitative easing is an aggressive bond-buying program designed to shore up liquidity among commercial banks, but the prospect of QE3 is becoming a very real worry for a number of economists. Even several voting and non-voting members of the Fed’s policy-making Federal Open Markets Committee (FOMC) are expressing concern about the impact the $2.7 trillion already pumped into the US economy via quantitative easing could have on inflation.


A few weeks ago James Bullard, president of the St. Louis Federal Reserve Bank and a non-voting FOMC member, expressed his unease regarding inflation to attendees of Credit Suisse’s Asian Investment Conference (AIC). “Some say that if inflation increases, then we know how to combat it,” he said. “That is true, but the hard-learned lesson of the 1970s was that if the inflation genie is let out of the bottle, it can be extremely difficult to get it back into the bottle.”  Bullard argues that the US economy is on a strong enough footing for the Fed to at least temporarily halt easy money.


Bullard, who is largely perceived as a centrist on economic issues, isn’t the sole FOMC member who has pushed for a temporary halt in easy money. Atlanta Federal Reserve President Dennis Lockhart, who, unlike Bullard, is a voting member of the FOMC, has also called for a change in policy, arguing that the improving US outlook offers a platform to watch how the economy evolves. “I would have to see some pretty severe circumstances before I endorse another round of quantitative easing,” he recently told Bloomberg Radio.


Others are ready to be more forceful in their attempts to put the brakes on easy money. Jeff Lacker, the head of the Richmond Fed and an FOMC voting member, says he’s uncomfortable with the size of the US central bank’s balance sheet and has even called for an interest rate hike “sometime in 2013.”


Bullard and his FOMC colleagues don’t question easy money’s positive impact. The US economy has gained strength over the last several quarters. In the past six months the unemployment rate has fallen to 8.3 percent from 9.1 percent. The issue is really about negotiating a timely exit from this policy so it doesn’t lead to high inflation, which would ultimately hurt consumption and send the economy into another nosedive.


Bernanke Remains Cautious 


Unlike Bullard (and Lockhart and Lacker), Fed Chairman Ben Bernanke is not prepared to hit the pause button on easy money. A number of other FOMC members agree with the Fed chief, according to a report issued by Credit Suisse’s US Economics Research Group. “Most voters on the FOMC are more concerned about the headwinds that higher energy prices might impose on economic growth,” Credit Suisse wrote in the report, released shortly after the FOMC’s April 25th meeting. At issue for Bernanke and some FOMC members is ongoing weakness in the US economy.


“We need to be cautious and make sure this [recovery] is sustainable,” Bernanke recently told ABC News’ Diane Sawyer. “We haven’t quite yet got to the point where we can be completely confident that we’re on a track to full recovery.”


The Fed chairman and his colleagues have a point. In March durable goods orders suffered their biggest decline in three years, slipping by more than 4.2 percent.


However, despite Bernanke’s concern about the strength of the recovery, launching a third quantitative easing program would take a significant “slowdown in the economic data,” writes Credit Suisse.


As long as Bernanke remains skeptical about the strength of the recovery the Fed is unlikely to take the training wheels off the US economy, which makes another round of quantitative easing a real possibility.


Photo: Skpy / Flickr