Harvard’s Feldstein: Fed Playing ‘Dangerous’ Game With Monetary Stimulus

Friday, 28 Sep 2012 10:42 AM

By Forrest Jones

The Federal Reserve is following a “dangerous strategy” with its decision to jolt the economy with a fresh round of monetary stimulus measures, possibly stoking inflationary pressures and swelling asset bubbles, said Martin Feldstein, former chairman of the Council of Economic Advisers and a professor of economics at Harvard University.

The Federal Reserve recently announced it will buy $40 billion a month in mortgage-backed securities from banks to pump liquidity into the financial system in a way that pushes down interest rates across the broader economy to spur recovery, a monetary policy tool known as quantitative easing.

Side effects to such a policy tool — branded by many as printing money out of thin air — include a weaker dollar, rising stock and commodity prices and mounting inflationary pressures.

The Federal Reserve’s monetary policy body, the Federal Open Market Committee (FOMC), hopes open-ended easing will lower unemployment rates.

“Although economic weakness now prevents inflationary price increases, these conditions will not last forever. At some point, demand will increase and companies will recover the ability to raise prices,” Feldstein writes in a Financial Times opinion piece, adding that inflation could arrive before unemployment rates fall.

“Such price inflation has historically been associated with tight labor markets and rising wages. But this time the unprecedented high level of long-term unemployment could cause the unemployment rate to remain high even when product markets tighten.” Feldstein added.

Quantitative easing won’t spur recovery and create the demand for jobs that the Fed wants to see.

The policy tool functions by lowering interest rates when cuts to benchmark lending rates don’t work on their own.

However, fiscal uncertainty is preventing many businesses from investing and hiring, Feldstein points out.

At the end of this year, tax cuts expire while automatic cuts to government spending kick in, a combination known as a fiscal cliff that could send the country sliding into a recession if left unchecked by Congress.

Read more: Harvard’s Feldstein: Fed Playing a ‘Dangerous’ Game with Monetary Stimulus