By Steven K. Beckner

(MNI) – In a rousing defense of quantitative easing, senior
economists at the Federal Reserve Board and the San Francisco Federal
Reserve Bank contend in research to be published Monday that the Fed’s
asset purchases will result in major job gains while preserving price
stability.

Without it, they say, the economy would be verging on deflation.

The researchers, writing in the San Francisco Fed’s Economic
Letter, predict that the Fed’s purchases of long-term securities,
including the $1.7 trillion bought through last March and the $600
billion to be bought by the end of the second quarter, will reduce the
unemployment rate by 1 1/2 percentage points without leading
to undue inflation.

The findings are based on a model which, in the words of the
research paper’s authors, “projects that lower long-term interest rates
produce higher stock market valuations and a modestly lower foreign
exchange value of the dollar.”

Fed Vice Chairman Janet Yellen favorably cited the research on
which the paper is based in a speech earlier this year. The paper was
written by San Francisco Fed director of research John Williams, who was
Yellen’s top policy advisor when she was President of that Bank and is
considered a potential successor, together with Fed Board senior
economist David Reifschneider and two other Board economists, Hess Chung
and Jean-Philippe Laforte.

They maintain that the changes in financial conditions brought
about by Fed asset purchases will “provide considerable stimulus to real
economic activity over time.”

According to their simulations, “the full program raises the level
of real GDP almost 3% by the second half of 2012.”

“In turn, this boost to real output makes labor market conditions
noticeably better than they would have been without large-scale asset
purchases, benefits that are predicted to grow further over time,”
Williams, Reifschneider and company write. “By 2012, the full program’s
incremental contribution is estimated to be 3 million jobs, with an
additional 700,000 jobs generated just by the most recent phase of the
program.”

“Increased hiring lowers the unemployment rate by 1 1/2 percentage
points compared with what it would have been absent the Fed’s asset
purchases…,” they continue.

To have gotten the same impact through conventional monetary
policy, the Fed would have had to cut the federal funds rate by
approximately 3 percentage points, they add, but this was not possible
because the Fed cut the funds rate to near zero in December 2008.

Not only will Q.E. boost employment, the Fed economists contend,
“the simulations suggest that the asset purchase program has contributed
importantly to price stability.”

They find that “inflation is currently a percentage point higher
than it would have been if the FOMC had never initiated the program,
meaning that the economy would now be close to deflation.”

“The simulations also suggest that the longer-run inflationary
consequences of the program are likely to be minimal, as
portfolio-balance effects rapidly fall to zero and conventional monetary
policy adjusts to bring conditions back to baseline,” they go on.

“In part, this long-run neutrality reflects that agents in the
model have confidence in the FOMC’s determination and ability to
maintain price stabilitya belief that policymakers ratify,” they add.

The Fed researchers conclude that “the Fed’s large-scale asset
purchase program is providing significant support to real economic
activity and the labor market. Moreover, the program may also be
offsetting undesirable deflationary pressures appreciably, assuming that
agents do not anticipate a tighter stance of conventional monetary
policy over the medium term.”

They acknowledge that their estimates are “subject to considerable
uncertainty,” but assert, “it is likely that the Fed’s asset purchases
have significantly reduced the severity of the zero lower bound’s effect
during the current downturn.”

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