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Peterson Institute for International Economics

To Ease or Not to Ease? A Dialogue

Joseph E. Gagnon and Michael Mussa discuss the merits of the Federal Reserve and other central banks engaging in quantitative easing to stimulate the economy.

Edited transcript, recorded October 1, 2010. © Peterson Institute for International Economics.

Steve Weisman: To ease or not to ease? That’s the question we’re discussing today at the Peterson Institute for International Economics with Joseph Gagnon, senior fellow here, and Michael Mussa, senior fellow, who have different views about whether the Federal Reserve and other central banks in developed countries should engage in what is called quantitative easing. Joe, first tell us what quantitative easing is.

Joseph Gagnon: Quantitative easing is what central banks do when their normal policy rates—typically overnight rates—get to zero or essentially to zero. You can’t lower them below zero. And so, what you can do is try to operate on other margins of the economy. So, you tend to try to push other interest rates down or push other asset prices up. What I am proposing is that the Federal Reserve try to push down interest rates farther out the yield curve, so two-year, three-year, maybe up to four-year interest rates, say on Treasury bills.

Steve Weisman: How should they go about this?

Joseph Gagnon: They would announce their intention—their target to the market so the market would understand what they’re doing—and then they would make large purchases of these assets as much as needed to drive the rates down to where they would like them to be.

Steve Weisman: How much might this take?

Joseph Gagnon: I think at the current situation, it’s not really worth doing it unless you’re going to do something noticeable. The four-year Treasury yield is currently one percentage point, so I would suggest targeting that at 0.25, a quarter of a percentage point, which would be a 75 basis point cut, which would be pretty substantial action, but not unprecedented by monetary standards. It would be the first action they’ve taken in about 18 months, so in some sense, it’s been overdue.

Steve Weisman: I think you said this could involve hundreds of billions and maybe even closer to a trillion in purchases before it’s done.

Joseph Gagnon: It could, yes.

Steve Weisman: The reason for this is that the economy, in your view, needs more stimulus—monetary stimulus in this case. Michael Mussa, you’ve just delivered your assessment of the global economy, what do you think of engaging in this level of monetary stimulus?

Michael Mussa: First I think it needs to be recognized that we’ve already done a substantial amount of quantitative easing. The Federal Reserve’s balance sheet has become much larger than it was before the crisis—banks have a trillion and a quarter or so of excess reserve. The question is: Should we go further at this stage? My view is that we took emergency and extreme measures at the height of the crisis when circumstances looked likely to become far worse than what has actually transpired. Fair enough. I thought that was the right thing to do. I don’t think we should back away from it substantially at this stage until a recovery is more firmly established. But to go further in the direction of substantially greater quantitative easing, when our problem is really that the expansion is a little slower than what we would have hoped does not impress me as sound policy. There’s a certain point where you need to say, “Look, we pursue extreme measures in extreme circumstances, but we’re not in the business of supplying continually more boosts to the economy once we’re pretty much beyond the limits of our normal actions.”

Steve Weisman: But this has been the worst economic downturn in generations, and the recovery is very disappointingly slow. Why do you think this is overkill? What risks do you see?

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Originally published at the Peterson Institute for International Economics.© 2009 Peterson Institute for International Economics.

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