The Federal Reserve’s decision to enter the New Year by extending and enlarging its policy of quantitative easing is another step toward “helicopter money”—that is, directly increasing the public’s cash balances by an injection of high-powered money. This could be done by dropping money from helicopters or by having the U.S. Treasury print checks while the Fed printed money. The idea is to use the printing press to stimulate the economy by directly injecting new money into the spending stream without relying on lower interest rates and the financial system.
So far the Fed has resisted the temptation to turn to helicopter money. But in entering its fourth round of quantitative easing (QE4), the Fed will buy $85 billion worth of mortgage backed securities and longer-term Treasuries per month until expected inflation reaches 2.5 percent, or unemployment falls to 6.5 percent. The Fed’s macroeconomic models predict those thresholds won’t be reached until mid-2015.
With the end of Operation Twist, the Fed has largely depleted its stock of short-term Treasuries. Under that program, the Fed bought $40 billion worth of longer-term Treasuries per month but sterilized those purchases by selling an equal amount of short-term bills. QE4 will add more than $1 trillion to base money in 2013 because none of the outright purchases of MBS ($40 billion per month) and Treasury securities ($45 billion per month) will be sterilized. Consequently, the Fed’s balance sheet will expand to more than $4 trillion by 2014 from less than $1 trillion prior to the 2008–09 financial crisis.
The explosion in base money has mostly ended up being held as excess reserves at the Fed and hasn’t had much impact on the monetary aggregates. Weak credit demand (even at ultra-low interest rates) due to the efforts of private borrowers to rebuild their balance sheets, along with uncertainty due to regulatory fog and the “fiscal cliff,” and the payment of interest on excess reserves, have helped prevent the fourfold increase in the Fed’s balance sheet from spilling over into rapid money growth and inflation—as least for the time being.
The danger is to think that rapid increases in the monetary base will keep nominal interest rates permanently lower and that the excess reserves will not eventually be lent out in search of higher returns. The Fed’s short-term vision and its acceptance of the idea that monetary policy can effectively generate maximum sustainable employment ignore a basic truth—printing money cannot substitute for the real determinants of prosperity. Increasing the range of options open to individuals depends on greater economic freedom, not on destroying the value of money by creating an excess supply.
Read More at forbes.com . By James Dorn.