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Issue Analysis

    September Surprise: Fed Hints At More Monopoly Money

    If at first you don't succeed...

    Federal Reserve Chairman Ben Bernanke offered a robust defense of the effectiveness of the central bank's easy-money policies in his speech Friday at the Fed conference here, and left little doubt that he is looking toward doing more to give the economy a lift at the Fed's next policy meeting in September.

    Bernanke didn't come right out and say he was ready for another round of quantitative easing but he never really does. To paraphrase one of the greatest fictional gurus in history: "The hinting is strong with this one."

    The Fed Chairman has an almost missionary zeal for his way of dealing with an economy that seems to take two steps back for every one step forward.

    "A balanced reading of the evidence supports the conclusion that central bank securities purchases have provided meaningful support to the economic recovery while mitigating deflationary risks,"Mr. Bernanke said.

    He played down the costs of these policies at many turns. To date they haven't damaged the functioning of markets in which the Fed operates—including mortgages securities and Treasurys, he said. They haven't caused a surge inflation expectations or a dangerous buildup in financial leverage, and the Fed's programs are more likely to make money for taxpayers than lead to large losses, he said. Many of the Fed chairman's critics will disagree with him on these points, but it is clear where he stands.

    Many of those critics believe that QE2 was such a failure that a third round of easing wouldn't even be considered.

    Maury Harris of UBS is just out with a note that suggests QE2 failed:

    "The evidence that QE2 boosted economic activity is lacking. Yields moved higher and equity markets did as well, although the latter was justified by rising corporate earnings. They importantly reflected better volumes, which probably cannot be traced to any believable instantaneous response to policy that works with a lag."

    The Fed would probably disagree, claiming the easier financial conditions inspired the economic rebound that lasted all of, uh, two quarters. Totally worth it.

    There are numerous critics of Bernanke's approach which, in the end, don't matter much to him. As the head of a largely unchecked quasi-governmental entity he is free to do practically anything he wants, whether past results support repeating efforts or not.

    Is Ben Bernanke so invested in this attempt at balance-sheet expansion that he will push forward an extension of the policy despite its economic ineffectiveness and speculative distortions? It is on this question that the prospect for QE3 ultimately turns. Given Bernanke's disregard for the statutory restrictions of the Federal Reserve Act (which I've detailed elsewhere) and his clear willingness to expand the Fed's balance sheet to breathtaking leverage ratios, it may not be helpful to judge the prospects for Fed policy on the basis of what would be reasonable, empirically sound, or even legal. Moreover, the objections of various Fed governors to QE2 have been based more on the idea that "we've done enough," rather than any recognition that the policy itself is ill-advised, and would be so even in a further economic downturn because it doesn't act on any binding economic constraint in the first place.

    It's comforting to know our betters are looking out for us, no?