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Monday, November 01, 2010

QEII: Even if Real Rates Fall and Expected Inflation Increases, Will Firms and Households be Induced to Increase Consumption and Investment?

It seems to me that everyone fighting today over whether QEII will work are worried about whether the Fed can affect real rates, but are forgetting about the second step in the process. Once real rates rates fall, firms and households then have to be induced to borrow more, then consume or invest (I'm including the response to expected inflation in this). Even if we manage to change real rates, and I have never quarreled with the Fed's ability to do this (though the extent depends upon their ability to affect expectations), why do people think it will bring about a strong consumption and investment response in the current environment? As Paul Krugman notes today, firms are already sitting on mountains of low opportunity cash and they aren't investing, and loans to consumers are already pretty cheap and they aren't increasing their consumption [Update: Or maybe you are hoping for a boom in exports as other countries allow the dollar to depreciate against their currency?]. Can the Fed create a enough expected of inflation (which it would have to validate later, or it will lose credibility and this will never work again) to change the behavior of firms and consumers enough to really matter?

    Posted by on Monday, November 1, 2010 at 01:06 PM in Economics, Monetary Policy | Permalink  Comments (44)



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