Romney joins the economic swamp critters

ECONOMICS:Romney’s language echoed that of the ‘liquidationists’ of the 1930s, who argued against doing anything to mitigate the Great Depression

LAST WEEK Ben Bernanke, the Federal Reserve chairman, announced a change in his institution’s recession-fighting strategies. In so doing, he seemed to be responding to the arguments of critics who have said the Fed can and should be doing more. And Republicans went wild.

Now, many people on the right have long been obsessed with the notion that we’ll be facing runaway inflation any day now. The surprise was how readily Mitt Romney joined in the craziness.

So what did Bernanke announce, and why?

The Fed normally responds to a weak economy by buying short-term US government debt from banks. This adds to bank reserves; the banks go out and lend more; and the economy perks up.

Unfortunately, the scale of the financial crisis, which left behind a huge overhang of consumer debt, depressed the economy so severely that the usual channels of monetary policy don’t work. The Fed can bulk up bank reserves, but the banks have little incentive to lend the money out, because short-term interest rates are near zero. So the reserves just sit there.

The Fed’s response to this problem has been “quantitative easing”, a confusing term for buying assets other than Treasury bills, such as long-term US debt. The hope has been that such purchases will drive down the cost of borrowing, and boost the economy even though conventional monetary policy has reached its limit.

Sure enough, last week’s Fed announcement included another round of quantitative easing, this time involving mortgage-backed securities. The big news, however, was the Fed’s declaration that “a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens”.

In plain English, the Fed is more or less promising that it won’t start raising interest rates as soon as the economy looks better, that it will hold off until the economy is actually booming and (perhaps) until inflation has gone significantly higher.

The idea here is that by indicating its willingness to let the economy rip for a while, the Fed can encourage more private sector spending right away. Potential home buyers will be encouraged by the prospect of moderately higher inflation that will make their debt easier to repay; corporations will be encouraged by the prospect of higher future sales; stocks will rise, increasing wealth, and the dollar will fall, making US exports more competitive.