Peter Fisher, head of fixed income at BlackRock, finds little reason for the Fed to act, addressing the four rationales under which it might, and discussing why they would not apply or would not work in the current environment.
Read the complete article at Fed risks diminishing returns with more QE – FT.com.
There are four rationales that could explain why the Fed might now increase the size, or change the composition, of its balance sheet. While the Fed could act, it risks diminishing returns and perverse outcomes.
First, there is the “bank liquidity” rationale. To avoid a bank panic a central bank can rapidly expand its balance sheet to keep private bank balance sheets stable… it does not provide a compelling reason for the Fed to act in response to economic weakness.
Second, there is the “asset price” rationale which rests on the theory that if the central bank buys assets it can create momentum behind a rise in asset prices, stimulate investor animal spirits and create a virtuous cycle of confidence that will support economic expansion.This seemed to be part of the justification for the Fed’s actions in the autumn of 2010. While it did drive risk assets higher for a few months, there was little follow-through in economic activity in 2011. This approach provides little more than a bridging operation and the question remains: a bridge to what?
Third, there is the “credit channel” rationale based on the theory that if the Fed holds down long-term interest rates it will stimulate private credit creation and, thus, economic expansion…. at this point, pursuing lower rates by the Fed buying more Treasury and agency securities could have a perverse impact on credit availability.
Finally, there is the “radical monetarist” rationale to avoid deflation by flooding the banking system with enough “money” to prevent prices from falling… There are real challenges the Fed would have to overcome to pursue this rationale.