Quantitative Easing as a Dangerous Fad

A recent essay, Allan Meltzer makes some important points:

Quantitative easing (QE) is the latest central bank fad. After years of QE by the US Federal Reserve, the Bank of Japan, the Bank of China and the European Central Bank have adopted their versions of the policy. The immediate effect was a depreciation of each exchange rate and an increase in some measures of monetary growth. I will discuss the US experience and ECB problems here.

Putting aside the hype, adopting the QE policy consists of two principal changes. First, the central bank no longer limits its purchases to very short-term, safe assets. It buys other instruments, ones that it formerly spurned as too risky for central banks. Second, the central bank commits to a large increase in bank reserves.

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QE built in many problems for the future. One of the biggest is that the Fed enabled the Treasury to finance enormous deficits at exceptionally low interest rates. Large losses await those who hold the bonds when rates rise, as they will. A second problem is that pensioners took on greater risk to maintain earnings. Instead of rolling over bank CDs, they invested in higher yielding, riskier assts. They, too, will take large losses. A major readjustment is in the offing. When interest rates return to past levels, or possibly climb even higher, many additional problems will become visible.

Among the main cheerleaders for the QE program are stock market traders and speculators who made large profits when stock prices rose. They, like the Fed, put too much emphasis on near-term events and too little on longer-term consequences.