Quantitative Easing

For anybody who's wondering what quantitative easing is, this Bernanke's 2004 paper Conducting Monetary Policy at Very Low Short-Term Interest Rates should begin to give you an idea (courtesy of the Calculated Risk blog).

As we are not so slowly but surely drifting into recession, deflation and indeed a "very low short-term interest rate" environment, I have a feeling we'll be hearing about quantitative easing more and more.

It would appear that the Fed can do a lot of things once it reaches a zero percent fed funds rate and it can't cut rates anymore (we're almost there). It can for example shape interest-rate expectations and signal that, not only are short-term rates very low, but the Fed will keep them very low for the foreseeable future. But for that to work, the paper goes on, the Fed needs to have credibility and actually do what it says it will do.

Interestingly, this just might explain one of the true conundrums of the Fed's rate policy during and after the 2001-2002 recession, namely why Greenspan kept rates so low (1%) for so long, basically well after the economy had strongly rebounded. Well, maybe he did that, under Bernanke's advice, because the Fed had promised to keep rates low for a while and, for the sake of its future credibility, it had to keep its promise.

Granted, the Fed's credibility has taken quite a knock lately as basically none of the sometimes creative measures it has taken over the past year has stopped or even slowed the hellish economic plunge.

Let's see if quantitative easing circa 2008-? works as well as the 2002-2004 version.