Let’s look at this from the lead article on the front page of Friday’s Wall Street Journal.
The Fed said Wednesday, at the conclusion of its last policy meeting of the year, that it would enter 2013 with a plan to purchase $85 billion a month of mortgage-backed securities, part of a continuing attempt to drive down long-term interest rates to encourage borrowing, spending and investing. The Fed said it didn’t expect to touch short-term rates until it saw the unemployment rate fall to 6.5% or lower, as long as inflation forecasts remain near its 2% target.
So they now have the idea that they can just multiply the monetary base by a factor of five or so and there will be no inflationary effect? I like that phrase “as long as inflation forecasts remain near its 2% target.” Who is making these so-called forecasts, and where did they buy their crystal ball? Did it occur to them to take into account that the monetary base is in the process of multiplying by 5 without the economy growing much at all? Exactly how do you even make a forecast of inflation without the monetary base/GDP ratio as your primary input?
According to data from the St. Louis Fed here, the entire monetary base of the United States as of November 2008 was around $800 billion. Then we had QE1, and suddenly it was about $1.7 trillion. Then QE2 and suddenly around $2.7 trillion. And now we’re going to be buying $85 billion more of assets per month, effectively monetizing all or nearly all of trillion-dollar-plus annual deficits. Should be approaching $4 trillion by the end of 2013. But don’t worry, our “forecast” is for inflation not to exceed 2%!
Here is the statement of the Fed's mission from Section 2A the Federal Reserve Act:
The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.
That's rather an explicit statement of what they're supposed to do: maintain monetary aggregates in a stable relationship with the economy, which in turn will lead to maximum employment, price stability, and "moderate" interest rates. Now they've just turned everything around 180 degrees. Our new number one goal is to drive unemployment down to 6.5%. We'll do that by having a blow-out expansion of the monetary base. Where do they possibly get the idea that they have control over the rate of unemployment, other than very indirectly influencing it through the blessing of stable money? Can anyone give one example from history where a five-fold expansion of the money supply without substantial economic growth moved unemployment down a few points and did not ignite inflation? Well, this is what is called hubris. Unfortunately, we know what follows hubris.
Here's a little news for them. No one knows when the inflation will come, but when it does come the value of the currency (against other currencies, or against gold or a basket of commodities) could drop to half (or maybe to a fifth) in the blink of an eye. And they will have no ability to stop it, because they have already done the damage. When you run your monetary policy like an Argentina or a Brazil or a Venezuela at the heights of their folly, sooner or later your currency will behave like the currencies of those countries.