The Fed Needs to Taper QE to Avoid Long-Term Risks

The Federal Reserve Board today is expected to announce plans to begin tapering its latest round of quantitative easing (QE). The possibility of tapering the QE program has at times created volatility in the stock market, and supporters of the monetary stimulus have argued that QE has not increased inflation.

However, Mercatus Center senior research fellow Steven Horwitz says that the Fed needs to begin tapering to not only prevent potential long-term monetary inflation risks, but also risks from the inflation of stock and asset prices.

We need to taper and taper quickly. Continuing to expand means a continued risk of inflation. The Fed's quantitative easing program hasn’t necessarily made it more likely that the expansion of the monetary base will turn into growth in the money supply and spending, but it does mean that if and when it does, the risk of damaging inflation will be that much higher. It also means that the process of unwinding the injection of all those reserves becomes that much more difficult. QE has probably also contributed to the run up in the stock market and other asset prices.

Horwitz also says that it isn’t clear the Fed’s QE program has provided any significant economic benefits.

There’s no real evidence that QE has helped the economy significantly. Providing liquidity during the crisis in 2008 was one thing, but the ongoing attempts to expand reserves and the money supply have mostly served to bailout banks from their bad mortgages and other assets that are being bought up.

Thinking that we needed more monetary easing in the first place misdiagnosed the problem. Some argue that our slow recovery is the result of a lack of aggregate demand. But the bad investments leading up to the financial crisis and the recession take time to unwind. It also takes time for entrepreneurs to reallocate those resources to new, better uses. Misguided policies that subsidize the mistakes leading up to the crisis have slowed the readjustment process even further. Every time we try to prop up housing prices or bail out failed industries, we slow recovery.

Because QE3 has been open-ended, it has created uncertainty and made investors nervous. Some sectors may see that open-endedness as a positive because they will benefit from added liquidity. However, the ability to engage in more QE at any time down the road can also be a source of further uncertainty.