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The Best of Economic Times, and the Worst

12:00 AM, Nov 13, 2010 • By IRWIN M. STELZER
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The first condition does not seem to be present. U.S. corporations are sitting on $2 trillion of excess cash, and the banks have ample lending capacity. QE2 is not likely to persuade the large banks to ease the tight credit standards now facing homebuyers and small businesses. Or induce businessmen to invest until they see some recovery in demand for their products. In Keynesian terms, Bernanke is pushing on a string.

The second condition required for QE2 to work without creating long-term damage is that the Fed know when to exit, and how. Bernanke says it does. But the Fed now has $3 trillion in assets on its balance sheet, and if it begins any substantial sales, it might cause a sharp downturn in the prices of shares and other assets. Especially, as is likely, if it decides to do so just when other market players reach the same conclusion and head for the exit. To whom, then, could the Fed sell trillions in assets, which is what exit means?

A whiff of inflation is one thing, the best of times if kept in the 2 percent range; let it hit double digits and we feel as if we are living in the worst of times. Doubt that, and recall the malaise created by Jimmy Carter’s double-digit inflation until the combination of Ronald Reagan and Paul Volcker sweated it out of the system. That sort of inflation will be avoided if Bernanke indeed knows when to exit that policy, and also knows how to exit it. Get that right, and -- with further apologies to Dickens -- he will have a good claim to have ushered in the age of wisdom, and ended the age of foolishness, in this context one in which monetary policy is unnecessarily hampered by the fear of runaway inflation. Many people think such knowledge is denied ordinary mortals, even central bankers, which explains the scramble for $1,400-per-ounce gold.             

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