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Tuesday, November 16, 2010

"How to Restore Confidence in the US Economy"

I'm guessing you won't like this idea very much. Roger Farmer argues that the Fed should stabilize the stock market in order to restore confidence in the economy:

How to restore confidence in the US economy without inflating a new asset market bubble, by Roger Farmer, Commentary, Financial Times: ...I have argued ... that more QE can create jobs and prevent a second Great Depression. But it matters how the policy is implemented. ...
Currently, investors hold more than a trillion dollars in excess reserves at the Fed... The problem is that investors are fleeing from risk and are demanding safe assets. The Fed is uniquely positioned to provide a safe haven for investors by buying risky securities from the public and replacing them with interest bearing deposits at the Fed.
What kind of risky assets should the Fed buy? Mr Bernanke plans to purchase treasury bonds..., a better plan would be to ... buy and sell stocks with the goal of reducing private sector risk. How might this be achieved? ...
QE is a new, unconventional monetary policy and ... there are two ways that it can be implemented. One is to buy securities in fixed amounts each month. That is what Mr Bernanke plans to do, although he proposes to buy bonds rather than stocks. The other is to buy and sell shares to stabilize fluctuations in the stock market. I propose this second strategy.
If the Fed were to announce that the Dow would not be allowed to drop below 11,000 over the next three months, for example, it would provide the confidence to private investors to move back into the market and spend some of the $1,000bn in excess reserves that are sitting in the banking system. But guaranteeing no downside to stocks is not, on its own, a good idea. The Fed must also limit swings on the upside. If QE simply fuels another unsustainable asset market bubble it will have made the problem worse, not better. Just as conventional monetary policy stabilizes swings in interest rates, so unconventional monetary policy must stabilize swings in asset prices.

    Posted by on Tuesday, November 16, 2010 at 12:39 AM in Economics, Monetary Policy | Permalink  Comments (65)


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