The Washington Post Tells Readers That It Doesn't Understand How Monetary Policy Works

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Wednesday, 20 October 2010 04:59

A Washington Post editorial expressing doubts about the Federal Reserve Board's plan to boost the economy with additional quantitative easing told readers:

"it's not clear how the Fed will sop up all the extra liquidity it's creating once growth resumes." 

Actually, it is clear. The Fed has several tools to reduce the money supply and prevent inflation. It can raise the federal funds rate that banks pay for borrowing reserves overnight, it can increase the reserve requirement, forcing banks to hold more reserves, and it can raise the interest rate it pays on reserves encouraging banks to hold more reserves. One would hope that the Post's editors would be familiar with these mechanisms.

The piece then goes on to express its real concern:

"The deeper fear is that QE2 is a cyclical solution to a structural problem. Many corporations are flush with cash already but simply don't see enough opportunities for profitable investment within the United States. The list of reasons include households with too much debt; political and policy uncertainty; a growing mismatch between the skills of unemployed U.S. workers and the available work; and a broader shift in economic dynamism from the developed to emerging markets."

This is an interesting story. All the evidence, including what appears in the Washington Post news section, suggests that we have a cyclical (i.e. not structural) problem. In other words, unemployment as soared because the economy lacks demand.

The problem is that the economy was driven by an $8 trillion housing bubble. Now that this source of demand has disappeared, the economy needs a new source of demand. In the short-term this demand can only come from the government and from very stimulatory monetary policy. In the longer term, a lower dollar is needed to move the trade deficit closer to balance.

There is zero evidence to support the Post's claim of, "a growing mismatch between the skills of unemployed U.S. workers and the available work." It would be an important news item if it uncovers any evidence of this phenomenon.