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July 5, 2013

Fed stimulus?

There is a general worry that if and when the Fed dials back on its extreme asset buying programs, the economy will lose a source of stimulus and might stagnate or decline. On the other hand, there is not one iota of credible, empirical evidence that what the Fed has been doing is, in fact, stimulative. Suppose instead that the Fed activities have crowded out private investment or credit market activity, have been contractionary all along, and have delayed recovery. In this case, losing this Fed policy would be a good thing.

Well, maybe not. Medicine can have a placebo effect.  So removing that medicine could create worries that problems will follow and generate defensive behavior. What we might hope for is that the talking heads would be a little more careful with regard to characterizing what the Fed has been doing and what the effects might be of getting rid of the current policy. This new pill will be difficult to swallow for those who belong to the cult of low interest rates.

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