Econintersect: Denver, January 8, 2011 – Federal Reserve Vice Chairman Janet Yellen defended the central bank’s asset purchases, saying they will ultimately result in increasing private payroll jobs by 3 million. See graph below for effects of QE2 only. She said the purchases have prevented the country from slipping into deflation.
“Inflation is currently a percentage point higher than would have been the case,” Yellen said in a speech Saturday, January 8 in Denver. “In the absence of such purchases, the economy would now be close to deflation.” Text of the speech is available from the Federal Reserve.
The process of asset purchases falls under the technical name “qunatitative easing” (QE). The Fed creates additional dollars for the purpose of purchasing assets, such as MBS (mortgage backed securities) and U.S. Treasury securities. The objective is to supply liquidity when private sources of capital have dries up because of contracting (and defaulting) debt. The Fed completed a QE process in early 2010 that totaled $1.7 trillion and announced a second round, QE2, in the fall of 2010, which will amount to $600 billion upon completion later this year. Some call the process “printing money”. Fed officials have called the process “creating credit”.
The above description is rather braod brush. A more detailed description of QE is available at The New York Times.
Some economists have objected to QE2 by arguing that there has been an increase in structural unemployment that is not amenable to government intervention. Other critics say the Fed is risking future inflation by vastly increasing the quantity of reserves that banks hold at the central bank. Still other critics say the Fed’s new strategy might generate future financial imbalances like the housing bubble that peaked in 2006. A fourth line of criticism says that the Fed will hamper growth in foreign economies by driving down the value of the dollar.
Critics, both domestic (often political) and foreign (primarily governments), have suggested that QE has incumbent problems:
- Creates inflation risk because increased reserves at the central bank might unleash an uncontrolled flurry of lending.
- Establish conditions for a new asset bubble like the housing bubble of the early 2000s.
- Fail to address the major economic issue of unemployment, which, critics say, is structural and not cyclical.
- Produce leakage of liquidity into other countries where there are high inflation pressures that would flare further with more dollars as fuel.
Economists are divided on these issues because there are conflicting “theories” on monetary policy. The area with the most unanimity is that the risk of dollar devaluation is real, an idea supported even by some Fed governors.
Yellen gave a detailed accounting of the benefits the central bank sees from its November decision to start a second round of asset buying, adding her voice to a defense of the policy by Chairman Ben S. Bernanke and the FOMC. Yellen responded to criticisms (above) by saying, “…net private capital flows to Latin American and Asian EMEs (reported as a share of the aggregate GDP of those EMEs) were substantial in the second half of 2009 and the first half of 2010 but were not obviously outsized compared with levels prior to the crisis.” See her graph, below.
Yellen dismissed concerns that inflation will flare up, saying weak labor demand will be helpful in “mitigating the risk” and the Fed can “tighten policy when needed” by increasing the interest rate it pays on excess bank reserves.
Yellen spoke at the Allied Social Science Associations annual meeting in Denver.
Source: Speech transcript from the Federal Reserve .
