While Paul Krugman has been warning that a second round of quantitative easing is unlikely to achieve its goal of raising inflation expectations, Cato’s Mark Calabria has a bizarre post in which he warns that QE2 might work:
The real impact, and the greatest risk, of QEII is that it changes expectations of inflation. It seems pretty clear that the Fed wants higher inflation than we have now. QEII sends the signal that the Fed will do everything possible to create that additional inflation. QEII also runs the real risk that the Fed ends up “monetizing the debt” – both reducing the political pressure to address our fiscal imbalances as well as undermining the dollar.
This is totally bizarre. The Fed’s target is to maintain an inflation rate of around 2 percent. For a while now, the inflation rate has been below 2 percent. One of the goals of monetary policy should be to raise the inflation rate to bring outcomes back in line with the targets. Was inflation ruinously high when Bill Clinton was President? Was it ruinously high when Ronald Reagan was President? And why shouldn’t the dollar fall when we’re importing so much more than we’re exporting?
Getting this stuff right is the key to restoring growth. With inflation expectations back at a healthy level, real interest rates will be more in line with where they ought to be. Firms and individuals will be encouraged to stop hoarding cash (or treasuries) and instead to invest in the real economy. Consumers will buy fewer foreign-made products and our products will be more appealing to foreigners. What’s the problem?