How the Fed Boosts the Economy: Lessons for George Will

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Thursday, 13 September 2012 05:03

In his column today George Will notes the Fed's responsibility to maintain price stability and high employment and tells readers: 

"Achieving the former is the best thing the Fed can do for the latter."

Apparently Will has not been following what has happened in the economy recently. While inflation has remained low and relatively stable, unemployment has soared. He also apparently does not recognize how the Fed hopes to boost economic growth through quantitative easing.

The biggest impact from lower interest rates is probably from mortgage refinancing. This both directly generates economic activity through people employed in the process (e.g. banking staff, appraisers etc.) and indirectly by reducing payments and freeing up money for other consumption.

The second biggest impact is on lowering the value of the dollar relative to other currencies, which will reduce the trade deficit. Anyone who does not want a large budget deficit and/or negative private savings (like we had at the peak of the housing bubble) must want to see the trade deficit move closer to balance. This is an accounting identity -- there is no way around it. And, there is no plausible mechanism to get the trade deficit closer to balance except by reducing the value of the dollar.

For some reason Will fails to mention either the impact of quantitative easing on mortgage refinancing or the impact on the trade deficit. There is also zero evidence of the hyper-inflation that he and other opponents of more aggressive Fed actions have been warning about for years.