The Fed is using an impressive range of firepower to counter the greatest deflationary threat since the Great Depression. With such massive injections of liquidity, however, it is not surprising that leading figures are already debating exit strategies and the extent of the longer-term inflationary threat. It is a fascinating debate to watch.
John Taylor worried in the FT last month that “extraordinary measures have the potential to change permanently the role of the Fed in harmful ways.” He said, “The success of monetary policy during the great moderation period of long expansions and mild recessions was not due to discretionary interventions, but to following predictable policies and guidelines that worked.”
Writing this week in the FT, Martin Feldstein is also anxiously looking ahead: “[W]hen the economy begins to recover, the Fed will have to reduce the excessive stock of money and, more critically, prevent the large volume of excess reserves in the banks from causing an inflationary explosion of money and credit. This will not be an easy task since the commercial banks may not want to exchange their reserves for the mountain of private debt that the Fed is holding and the Fed lacks enough Treasury bonds with which to conduct ordinary open market operations. It is surprising that the long-term interest rates do not yet reflect the resulting risk of future inflation.”
Robert Hall and Susan Woodward strike a more optimistic note in a piece on the VOX site: “[T]he Fed can control inflation by varying the interest rate it pays (or charges) banks on their reserve holding. Consequently, the Fed’s exit strategy need not be constrained by concerns about inflation – reserve interest-rate policy can take care of inflation, but the Fed should publically announce this policy.”