Quantitative Easing is the New Normal: The Rise of the Free Lunch Theory of Money

Quantitative Easing is the New Normal: The Rise of the Free Lunch Theory of Money

Central bank independence is dead, according to Foreign Policy, though the publication notes that the U.S. Congress has yet to get the message. 

A recent survey demonstrates how 61 percent of former central bankers surveyed around the world believe central banks will become less independent in the future.

The Fed’s congressional mandate states the central bank’s purpose is to “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”

Paul Tucker, a former deputy governor of the Bank of England, wrote in 2018 that central bank could “be incentivized to do whatever is needed to deliver their mandate, however far that reaches into fiscal territory.”

During the financial crisis, central banks implemented quantitative easing once manipulating short-term interest rate didn’t suffice. Central banks are still running QE programs. That’s not the only way in which the post-2008 economy differs from pre-crisis. Low natural real interest rates and the possibility of inflation ensures conventional monetary policy will not maintain price stability.

Federal Reserve Chair Jerome Powell, at a June conference, suggested forgetting about the old way of doing things. “Perhaps it is time to retire the term ‘unconventional’ when referring to tools that were used in the crisis.” 

As Foreign Policy writes, “Make the unconventional conventional.” Quantitative Easing is the new normal.

In other words, quantitative easing will be part of the new normal. That’s already started to happen. Take one example: The New York Fed recently implemented large repurchase agreement operations, essentially launching a targeted version of QE to prevent the collapse of one far-away corner of the financial markets with a liquidity problem. This has gone largely unnoticed in the public domain.

There are two ways to interpret the Fed’s so-called normalization of the abnormal.

“It is either a power grab or an administrative agency doing its best to fulfill its congressional mandate in a new economic environment,” writes Foreign Policy. “In reality, it is probably both. The fact that such blatant overreach is necessary should perhaps tell us something about the job itself, the state of the economy, and the state of the U.S. democracy. Under either interpretation, Congress is shirking its responsibility to govern the macroeconomy by allowing the Fed to redraw the boundaries of its own policy jurisdiction.”

Currently, the Federal Open Market Committee, Fed’s monetary authority, is comprised of 10 people.

QE was initially embarked upon to purchase mortgage debt to keep interest rates down and bring a dead housing market back to life. It defined the past decade. 

“It was the decade of the central bank,” said Quincy Krosby, chief market strategist at Prudential Financial. “Stimulus was wanting, and the burden fell on the central banks to normalize the environment.”

Central banks cut borrowing rates more than 50 times the past decade and instituted “money printing” QE programs of nearly $11 trillion. 

“What was once extraordinary has become ordinary, not just in the United States but all over the world,” Krosby said.

In the wake of quantitative easing, the Modern Monetary Theory has emerged, suggesting that governments can increase debt to pay for social programs. Ethan Harris, head of global economic research at Bank of America Merrill Lynch, says its the “the free lunch theory of monetary policy” 

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