Friday, August 26, 2011

Woodford in the Financial Times

I agree with some of Woodford's conclusions, but was having a little trouble with his argument. First, he states
The economic theory behind QE has always been flimsy.
Yes, exactly. But then he states:
The original argument, essentially, was that the absolute level of prices in an economy is determined only by a central bank’s supply of base money.
The way Bernanke and others typically made the argument was to state that they could manipulate the relative supplies of short and long-maturity debt, and with the short end of the term structure of interest rates essentially pegged at zero, long rates would go down.

Woodford goes on to discuss how it matters whether the reserves are increased permanently or not. There is a sense in which that is correct, but I think it's also true that quantitative easing could take place in such a way that the reserves are out there forever, and it would not matter.

Woodford also states:
Uncertainty about the economic outlook is likely now the most important obstacle to a more robust recovery. The problem is not just uncertainty about Fed policy, but the fact that the Fed has become harder to “read” does not help.
I agree with that. The policy change in the August FOMC statement indeed makes the Fed harder to read, and adds to uncertainty, which is not good.

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