Will the Fed's Easy Money Slow the Economy--Again?

It is widely believed (albeit not at the Fed) that easy money policies by the central bank have contributed substantially to the asset bubbles and busts of the past decade. Tech stocks, real estate, consumer credit (remember the days when anyone with a pulse and a signature could get a loan?), and commodities (especially oil) all boomed and busted partly because of low interest rates fostered by the Fed. Each cycle enriched financial markets insiders, but weakened consumers and the broader economy. Nevertheless, the Fed is at it again with quantitative easing (i.e., buying Treasury securities in the open market) and history may be repeating itself.

Oil prices have risen above $90 a barrel, and predictions for $100 oil are becoming fashionable. Regular gas is more than $3.00 a gallon. Metals prices have been rising, and today's Wall Street Journal (P. C1) reports that holdings of metals have become concentrated, suggesting a flare-up of speculative buying. With the economy still struggling to climb out of the septic tank, the liquidity the Fed has been pouring into the financial system apparently isn't being used to build factories or develop software, or for badly needed repairs of bridges and highways. It evidently is going into short term financial market plays, the same kind of stuff that's bedeviled the economy for the past decade.

The Fed wants inflation to stimulate consumer spending. It may well get a dose of inflation this year, if oil and other commodities prices keep rising. But that isn't beneficial inflation. As gasoline, heating oil, diesel and aviation fuel go up, consumers spend more on energy and less on everything else. Oil producers get wealthier (perhaps increasing funding for Iran's nuclear weapons program), while American businesses struggle to keep sales up. Hiring may slow, retarding the recovery of employment levels. The economy could stumble. This is what happened in 2008 and it could easily happen again.

Just when everyone thought fiscal stimulus was dead, the Republicans ignored the mandate from voters in the recent mid-term elections and agreed to a tax deal with President Obama that increased the federal deficit. Okay, so the increase was necessary to give tax relief to the wealthiest Americans, who are major targets of campaign fundraisers now that the Supreme Court has ruled that political sugar daddyism is a Constitutional right. But it demonstrates that fiscal expansiveness lives. John Maynard Keynes' legacy may yet be vindicated by the GOP.

The Fed has powerful monetary tools. These tools, however, can have powerful unintended consequences. Need the Fed pile on with more easy money?

As a bank regulator, the Fed has appropriately been leaning on its regulatees to be more prudent. Perhaps, just perhaps, it ought to consider whether prudence might not be a weapon in its monetary arsenal as well.