QE2

Recently the Federal Reserve announced plans to perform more quantitative easing. The details of the plan, dupped QE2, have not been revealed, but analysts expect it to involve purchases of Treasuries. These purchases should drive down interest rates. The Federal Reserve's hope is that lower interest rates will lead to more growth in the economy and a reduction in the unemployment rate.

The Federal Reserve's hope seems misplaced. Interest rates are very low right now, and the economy is still not growing very much. Unemployment is also still at very high levels. The only outcome seems to be that it is easy for companies to raise money.

Companies have been taking advantage of the low interest rate environment to issue debt. The Wall Street Journal describes how Wal-Mart has issued bonds that pay very little interest. There's no evidence that this easy access to capital has spurred companies to increase their hiring in America. In fact, the companies are likely using this money to expand abroad. The Wall Street Journal article about Wal-Mart closes by observing of Wal-Mart's sales, "fastest growth coming from China and Brazil". This makes sense since economies like China and Brazil have been growing faster than America. By making money easy to get, the Federal Reserve is probably making it easier to chase growth abroad.

Meanwhile, states, counties, and cities across America have been cutting back. These cutbacks which include layoffs are rippling through the American economy. Many economists have noted that the benefits of federal stimulus spending has been undercut by cutbacks at the local level. If the Federal Reserve wants to improve the American economy by spreading money around, it should reduce the burden on local government. One seemingly straightforward thing would be to purchase municipal bonds with the money that would be spent on Treasuries. That would give local governments money to ride out the current recession.

It is still important for local governments to reach the right size. If that means shrinking, then they should shrink. By helping local governments in their current predicament, the Federal Reserve runs the risk of impeding needed corrections. The moral hazard of a bailout of local governments is a serious threat. However, QE2 is going to create moral hazard. In fact, there is evidence that QE1 is already creating moral hazard. If the Federal Reserve wants to embark on QE2, it is better for it to help local governments instead of helping inflate another bubble due to weak lending practices.