Nov 18, 2010 10:33 am


The battle over the Fed QE2 (quantitative easing) is raging. Sarah Palin is not the only one who asked Ben Bernanke to cease and desist his latest bout of money printing.

“The planned asset purchases risk currency debasement and inflation, and we do not think they will achieve the Fed’s objective of promoting employment,” said the letter, signed by 23 people including Cliff Asness, who runs AQR Capital Management LLC, one of the world’s biggest hedge funds; Stanford University Professor John Taylor, creator of a monetary-policy formula used by the Fed; and Douglas Holtz-Eakin, a former Congressional Budget Office director.

Ben Bernanke embarked on QE2 to devalue the dollar to help American exports, to long term interest rates to help the housing market and to increase inflation to buoy the stock market, make Americans feel richer and spend more.

Alas, the global economy refuse to cooperate. Bond vigilantes are gunning for Ireland, the Euro teeters and the dollar rises. Stocks retreat on Asian inflation, Euro debt fears. And long term interest rates are rising instead of declining.

Poor Bernanke, the American economy is tied to the global economy and the world economy refuses to march to the beat of his drum.

May I just add that it is absurd not to include food and fuel in the inflation rate. It does not feel like zero inflation to me. Not when I have to pay 90 cents for a bagel.

I was delighted to discover that I was not off base. David Brooks writes

Ethan Ilzetzki of the London School of Economics and Enrique G. Mendoza and Carlos A. Vegh of the University of Maryland examined stimulus efforts in 44 countries. In a recent National Bureau of Economic Research paper, they argued that fiscal stimulus can be quite effective in low-debt countries with fixed exchange rates and closed economies.

Stimulus measures are generally not as effective, on the other hand, in countries like the U.S. with high debt and floating exchange rates. The authors of the paper pointed to a series of specific circumstances that complicate, to say the least, the effectiveness of increasing public spending: How much stimulus money ends up flowing abroad? What is the relationship between fiscal policy and monetary policy? How do investors respond to fear of future interest rate increases?


Last week’s 14 per cent drop in US mortgage activity, coming during the first full week of QE2, is a reminder of the limits of monetary and fiscal stimuli. Housing, as the main source of both household wealth and consumer credit, is a critical monetary transmission mechanism. Considerable fiscal heft also stands behind housing as government-controlled lenders now guarantee 95 per cent of all new mortgages.

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