Bernanke: What the Fed did and why

Op-ed on today's WP.  What keeps Bernanke up at night? High unemployment plus the fear that very low inflation might yet become deflation.  The Fed is going to buy an additional $600 billion of long-term securities which it hopes will lower long-term interest rates.  This should encourage investment by lowering the cost of capital through one of two channels.  First, with lower Treasury yields corporations and state and local governments also will be able to lower the coupon rates on newly issued bonds.  Second, bond prices will rise and thereby shift private investors to the stock market, raising stock prices and thereby making new stock issues more attractive.  Bernanke also thinks higher stock prices will raise consumption and stimulate the housing market. 

So what's not to like?  I see two issues: (1) long-term interest rates are already at historical lows, will making them even lower make that much difference (more technically, how elastic is corporate investment and housing to lower interest rates?) and (2) the stock market has seen this coming for some time, so any stock appreciation may have already happened (look at the charts for September and October).  Harvard's Marty Feldstein (who taught macro to Harvard PhDs when I was there) sees even more serious issues.  In a FT op-ed on Tuesday, he argues that easing now runs the risk of creating yet another bubble in asset prices that will deflate once interest rates return to normal levels.  What would Marty do? 

The truth is there is little more that the Fed can do to raise economic activity. What is required is action by the president and Congress: to help homeowners with negative equity and businesses that cannot get credit, to remove the threat of higher tax rates, and reduce the out-year fiscal deficits. Any QE should be limited and temporary.