Like Krugman, Mankiw is worried about deflation, and he has a Keynesian view of how QE2 works, i.e. through interest rate effects on "aggregate demand." The interesting part is in this paragraph, where he nails some of the potential problems with QE2:
Moreover, I do see some potential downsides. In particular, the Fed is making its portfolio riskier. By borrowing short and investing long, the Fed is in some ways becoming the hedge fund of last resort. If future events require higher interest rates, the Fed will end up making losses on its portfolio. And even if doesn't recognize these losses (by not marking to market), it could end up paying more interest on newly expanded reserves than it is earning on its newly acquired portfolio of long bonds. Such a cash-flow deficit could potentially undermine the Fed's political independence (which is already not very popular in some circles). Yet if the Fed tries to avoid these losses by failing to raise rates when needed, inflation could indeed become a problem down the road. I trust the team at the Fed enough to think they will avoid that mistake.He's basically in tune with some of the issues that Kocherlakota raises here. I like this paragraph, but disagree with the last sentence. The Fed is trustworthy, in some sense, but I don't think they will be able to withstand the pressure to do the wrong thing when the time comes to do the right thing.