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Aug 12, 2010, 11.17 AM IST | Source: Reuters

Economists divided on effectiveness of Fed move

The Federal Reserve's abrupt shift to a renewed focus on monetary easing this week has raised questions on what the US central bank may do next and the degree to which further easing would be effective.

Economists divided on effectiveness of Fed move

The Federal Reserve's abrupt shift to a renewed focus on monetary easing this week has raised questions on what the US central bank may do next and the degree to which further easing would be effective.

The Fed on Tuesday acknowledged that the economic recovery had slowed and said it would keep its holdings of domestic securities at a steady level instead of letting them shrink gradually.

The Fed's move opened the door to but does not guarantee a more aggressive program of buying long-term assets to provide additional stimulus. The US central bank turned to a policy of buying assets, called quantitative easing, in 2009 after cutting borrowing costs to near zero.

Following are views from prominent economists on how effective further extensive asset purchases might be.

Rene Stulz, Professor, Ohio State University

"The key issue is to generate growth that is sustainable in the long-run. Quantitative easing will not do that. It will create more distortions in the economy as some rates are maintained artificially low and these distortions could lead to bubble-like phenomena, create instability, and make firms even more cautious. We have had extremely low interest rates, and they are not generating productive investment. The logic for quantitative easing is the same as the logic that brought us the subprime debacle through a flood of liquidity. It relies on excessive faith in the ability of policymakers to fine-tune the economy with no long-run costs. Such a faith is misplaced. The focus of policy should not be in finding ways to generate once more artificial consumption growth that is unsustainable in the long run."

James hamilton, Professor, Univ of California, San Diego

"The Fed has taken a very modest step which might help move long-term interest rates down a few basis points. The fact that they have not responded more aggressively to news of a weakening economy is an indication they are much less confident in using these less traditional tools, and have some worries about their longer-term ability to manage the additional trillion dollars in assets and liabilities that the Fed is currently carrying on its balance sheet. The Fed is also signaling that it would like to ease out of its specific support for mortgages and the housing sector and replace this with a goal of keeping overall long-term interest rates low."

Simon Johnson, Professor, MIT Sloan School of Management

"The Fed's latest announcement is unlikely to change much. The world economy is slowing down -- primarily due to the scar tissue left behind in balance sheets around the world, as a result of the global debt boom-bust-bailout cycle. Eventually very low interest rates will help restart growth; unfortunately, given our continuing lack of effective regulation and weak capital standards, it will also restart a dangerous cross-border credit boom."

Darrell Duffie, Professor, Stanford University

"If we get into a true Japanese-style liquidity trap, then more of the same QE, printing money to buy Treasuries, does not help much at all. Investors become relatively content to hold cash rather than spend it on new consumption and capital projects. Forecasts of low growth are self fulfilling. Deflation is a serious concern. We are not in a real liquidity trap at this point. Mr. Bernanke has explained in the past that he has a range of policy tools to avoid one. If we've learned anything about Mr. Bernanke during the crisis, it is that he is willing to take unusually strong measures when he feels they are called for. I expect no less of him now."

Robert Shiller, Professor, Yale University

"By buying Treasuries rather than directly supporting mortgage securities, the Fed is taking a risky strategy. Their program of purchasing mortgage securities in 2009 dramatically lowered the spread between mortgage rates and the ten-year Treasury yield, but now that program is gone. The housing market is at a crossroads now, with the expiration of the home buyer tax credit which seemed to have a dramatic effect on the housing market. If home prices resume the downward path they showed from 2006 to 2009, it would have a dramatic negative effect on confidence."

Matthew Slaughter, Prof, Dartmouth Coll Tuck School Oof Business

"The Fed is increasingly concerned about the trifecta of slowing economic growth, continued too-high un- and underemployment, and the threat of outright deflation. Continued very expansionary monetary policy may help stimulate aggregate demand and avoid deflation. But quantitative easing would not be a panacea, in particular because slow private-sector hiring and related capital investment and other demand triggers are not being driven by high capital costs. Japan offers a cautionary lesson here: problems with fiscal policy and broader structural economic policies can impede demand growth and hiring regardless of what monetary authorities do."

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