More on Feds Quantitative Easing

With as many scholarly viewpoints on Quantitative Easing and possible effects and outcomes of yet another round post the financial crisis that led to the recession, the one certainty is that the U.S. financial outlook remains uncertain.  The recent meeting of G-20 Finance Ministers and Central Bank Governors ("G-20") in a report provided by the International Monetary Fund ("IMF"), provides the following:

[I]nsufficient progress with repair and reform is weighing on credit growth, and slowing the normalization of monetary and fiscal policies, with adverse spillovers on emerging economies, through large and volatile capital flows. Accelerated financial sector restructuring and reform should thus be top priorities. Moving expeditiously to address the legacies of the crisis—including bank funding concerns, the resolution of weak banks, and the restructuring of balance sheets for distressed households—as well as to alleviate regulatory uncertainty will strengthen financial systems and help catalyze rapid private-demand-led growth.

Fiscal consolidation in advanced economies should begin in 2011, but the type and speed of adjustment should reflect different circumstances in different countries, especially interms of the pace of recovery and risks to fiscal credibility. On the whole, country consolidation plans for 2011 strike an appropriate balance between making a credible start toward strengthening public finances and continuing to support the recovery.

As outlined, accelerated financial sector restructuring and reform should thus be top priorities and fiscal consolidation should begin in 2011. This basically means that financial sector restructuring and reform should be top priorities and could be in jeopardy dependent upon the outcome of the mid-term elections, and fiscal consolidation should begin next year and can be "slowed or postponed in countries with more fiscal room. Monetary policy must remain the first line of defense, although this line is becoming increasingly thin in most advanced economies."

Another view is that of the Federal Reserve Bank of Minneapolis, where the authors of a research paper entitled Damage Control? Analyzing Policies to Repair Credit Markets state regarding policies proposed and action taken of the prior round of Quantitative Easing that they "find that they do little to resolve the market’s inherent adverse selection problem. We conclude that, unfortunately, these policies were (or would have been) most likely ineffective, and possibly even counterproductive, and we suggest options that may be more successful in addressing future market crises of this sort. Such findings have direct bearing on proposals now under consideration vis-à-vis regulatory design for segments of the financial industry that are currently subject to little oversight and regulation."  As for further quantitative easing, the Federal Reserve Bank of Minneapolis suggests:

Other policy options
An alternative policy that we analyze with the model is forced asset sales. Under this policy (not proposed), government would randomly select banks and require them to sell their loans. The policy would by force generate a pool of loans in secondary markets, just as requiring home mortgage owners to purchase home insurance ensures a wide risk pool. However, this standard solution to adverse selection problems would come at a cost of loan misallocation: In some instances, low-cost banks would be forced to sell their loans, reducing the market’s overall efficiency in terms of comparative advantage.

Another alternative would be for the government to commit to purchasing assets in the future at prices contingent on signals about loan value. Our model shows that such a policy would support the positive reputational equilibrium, meaning that reputation concerns would overcome adverse selection problems and result in efficient market allocations. The feasibility of such a policy deserves further research, but would necessitate a model in which governments can commit but private parties cannot. [Emphasis added.]

As to whether or not QE2 will happen or even will help restart the anemic U.S. economy, the only certainty is that it remains uncertain.  Stay tuned!

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