Evaluating QEII: A Rationale to Exit

Whereas the Fed’s alternative liquidity facilities and quantitative easing (QEI) responses to the financial crisis and deep recession were merited and effective, the rationale for QEII was muddled and the asset purchase program has been a stretch. When the Fed deliberated on QEII, the financial crisis had long ended and the economy had been recovering for over a year. The Fed’s assessments of the benefits and risks of QEII were dominated by its perceived need to respond to last summer’s “economic soft patch” and its excessive fears of a Japan-style deflation. Short-term cyclical concerns were put ahead of the significant long run-risks of massive purchases of US Treasury debt securities amid unsustainable government deficit spending, including potential undesired economic, inflation and financial outcomes as well as the sacrifice of the Fed’s credibility and independence.

Fortunately, QEII has not jarred market expectations; mark that up to the lingering low inflation—a typical cyclical pattern following recession. Now, with economic performance clearly improving and inflation rising, the risks of this unprecedented monetary expansion are increasing. Consequently, the Fed must set out an exit strategy, including a framework for managing reserves and normalizing interest rates.

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