By Greg Robb
WASHINGTON--The financial crisis of 2008 sent the economy into a tail-spin from which it has yet to fully recover.
In response, the Federal Reserve under Chairman Ben Bernanke has moved aggressively to try to get the economy back on
track, pushing short-term interest rates to zero and buying $3 trillion in assets.
Fed watchers have been split ever since about the wisdom of the Fed's action. Some believe the Fed is stoking
inflation and creating problems for itself down the road. Others believe the central bank is right to take extraordinary
In December, the Fed doubled down, saying it would buy $85 billion-a-month in Treasurys and mortgage-related assets
until the labor market returned to health.
The new round of asset purchases has renewed the debate about the benefits, risks and costs of the Fed's aggressive
approach to boosting the economy.
This is the backdrop for the Fed's two-day meeting next week, at which members of the Federal Open Market Committee
are expected to discuss the latest round of asset purchases, known as QE 3.
Two top Wall Street economists offer a better picture of how Fed watchers view the central bank's current policy.
James Glassman, a senior economist at J.P. Morgan Chase, generally backs the Fed's asset purchases. Josh Shapiro,
chief U.S. economist with MFR Inc., is uncomfortable with quantitative easing.
Q: What will the Fed do next week? What are your assessments of the benefits and the costs and risks of QE?
Mr. Glassman: I think they will decide to keep doing what they are doing and that is what Ben Bernanke and [Federal
Reserve Vice Chair] Janet Yellen have been saying.
To me, the benefits are very difficult to identify because the problem is we don't know what would have happened if
the Fed were not doing this.
I look at...the real rate of interest the market expects five years from now and those real rates are zero--[this is]
the footprint of the Fed's large-scale asset purchases. Investors are exiting cash and risk-free assets and moving
assets into other pockets. And I think this is why the auto market is coming back, why the real-estate sector is
I think the costs are more about public relations. [Some on the] Fed say the exit strategy is more complicated. [I
think] the exit strategy is not complicated. It is not a challenge to unwind what they are doing.
Fed policy is about managing the economy. The Fed is not trying to make money, it is not an investment company trying
to make money on a portfolio. So to me, all this discussion about mark-to-market losses and interest returned to the
Treasury is not monetary policy. We didn't create the Fed 100 years ago to worry about those kinds of things.
Mr. Shapiro: I agree that it is hard to know exactly what the impact is, both on the upside and the downside, because
we don't know how things would have been without what the Fed has been doing. I don't believe the level of interest
rates--which even before QE was very low--was the main impediment for the economy.
What the Fed is doing now is manipulating the fixed-income market which, in turn, is having an effect on risk assets
as Jim has very correctly pointed out. I think that anytime you manipulate markets to the extent that is being done now,
you run the real risk of all sorts of things occurring that are unintended consequences. The Fed has never proven to be
very good at forecasting the future, never proven to be very good at identifying bubbles of any sort, and I think what
they are doing now is playing with fire.
Q: So the sooner they stop the better?
Mr. Shapiro: Well, it can't be abrupt at this stage because markets are very much dependent on this flow right now. So
I think it is going to need to be a very gradual weaning process, but my feeling is the sooner, the better. But I agree
with Jim that they are not going to do anything very quickly now.
Mr. Glassman: Josh is exactly right that what the Fed is doing is distorting market prices. And there are costs to
that. But to defend the Fed, there are other distortions that you have to weigh against the distortion that the Fed
causes in the market. And to me, the main distortion that is driving the Fed now is: An under-employed economy can lead
to very bad outcomes. You make everybody super-cautious, businesses don't invest, we don't build capital, it has an
impact on our long-run growth potential.
I guess I am a little more sanguine. Most people understand that eventually, when rates normalize, rates are going to
have to rise from 2% to 4% or so. I agree it is not good for the Fed to be distorting markets but the truth is, this is
really just an extension of what they normally are doing.
Mr. Shapiro: The fundamental question is, were the 20 years that led up to the great crash a distortion? The super-
credit-cycle where the world got itself into incredible problems with debt and that drove economic activity and
everything else. Is that where you want to head back to? Is this the correct recipe for fixing these excesses, more of
the same that created it in the first place? By not letting markets do their job, you really are short-circuiting that
whole corrective process.
Mr. Glassman: I think that is right. It is clearer now that we were kind of living on steroids. I think the market is
sorting this out fairly well. I am skeptical that we'll just do that all over again, just because the Fed is pushing
rates down. I don't think the Fed wants to get us back to the old days. It is really more how can they ease the
adjustment to this better balance. And my guess is that the lessons that we've all learned from the housing cycle will
help to prevent a repeat of that.
Q: Jim, do you think the Fed is playing with fire?
Mr. Glassman: I don't. Obviously you don't like it when the Fed has to distort market prices. But I think the fire
they are worried about is high unemployment. And inflation is running below the Fed's target and I've never seen that
before. I really think the experience of the Japanese tells you it is a very difficult thing to get an economy out of a
deflation track. Those are the fires they are trying to fight, recognizing that what they do does distort market prices.
But there is enough movement in the market, away from the risk-free market So I don't think they are playing with fire.
Mr. Shapiro: My feeling is they are playing with fire. They have never proven to have a crystal ball that is better
than any other sort of monkey on Wall Street throwing darts at a dart board. The fact that they think they can look at
what inflation is a couple year out...and, bear in mind, when we talk about inflation and the Fed's target, the way we
report inflation in this country is not a cost-of-living index. There is no way you can walk around and say, well, my
cost of living is going up 1% a year. That is crazy. I am not a conspiracy theorist, but I think you need to bear in
mind it is not a cost-of-living index. And people's cost of living has gone up much faster than reported inflation and
in certain respects it is accelerating now. And I think we need to keep that in mind as we talk about, well, inflation
is not an issue and the Fed can keep the pedal to the metal and not worry about it.
Q: So the fire they are playing with is just higher inflation?
Mr. Shapiro: The problem is that everybody is doing the same thing, so you worry about currency debasement, but
against what? Against real assets to a certain degree. Because the ECB [European Central Bank] is doing the same thing,
the Japanese are doing the same thing, so what currencies are left for you to "crap out" against. We're kind of the
least worst at this stage which is why the dollar is well underpinned and politicians can sit around and do nothing and
we don't have a crisis on the fiscal side. But at some stage that changes, if the status quo just goes on forever.
Write to Greg Robb at AskNewswires@dowjones.com.
(END) Dow Jones Newswires
Copyright (c) 2013 Dow Jones & Company, Inc.