Tags: Roach | QE | time | bomb

Yale's Stephen Roach: Loose Monetary Policies Are a Ticking ‘Time Bomb’

Monday, 26 Nov 2012 10:05 AM

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The Federal Reserve’s low interest rates and open-ended liquidity injections that aim to make sure rock-bottom borrowing costs stay that way are serving as a ticking time bomb for the economy, said Stephen Roach, former chairman of Morgan Stanley Asia and current Yale economist.

The Fed recently announced a third round of quantitative easing (QE) whereby it will buy $40 billion a month in mortgage-backed securities from banks to pump liquidity into the financial system in a way that pushes down interest rates across the broader economy to spur recovery.

The move aims to jolt the economy and lower unemployment rates when slashing benchmark interest rates alone are not enough to spur recovery.

Editor's Note: Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

The Fed has rolled out two previous rounds of QE in the last four years, pumping a combined $2.3 trillion into the economy since 2008.

The most recent third round seeks to spark investing and hiring at a time when the country is trying to pay down debts and rebuild savings, and considering that the country faces massive debt burdens and yawning deficits, sooner or later, investors will avoid the United States and its markets and demand for Treasurys will pop and the bond bubble will burst.

“I fear that we have misdiagnosed the sources and causes of the recent financial crisis and we are putting misguided and misdirected policies in place both fiscal and monetary that are setting ourselves up for another crisis,” Roach told Reuters TV.

QE and deficit stimulus spending make sense during times of crisis, but the United States hasn’t been in a crisis for nearly four years now.

While growth is sluggish and unemployment rates remain persistently high, the economy is recovering.

“Is it appropriate to maintain the extremes of crisis to determine policy in the midst of a crummy recovery? I don’t think it is. The advocates of open-ended fiscal and monetary stimulus really are totally inarticulate on the exit strategy — how do we get out of this? What are the conditions that allow us to go back to normal interest rates, to normal budget deficits?” Roach said.

A task force headed by former Sen. Alan Simpson, R-Wyo., and Erskine Bowles, chief of staff under President Bill Clinton, outlined ways to narrow deficits and pay down debts though the Obama administration put it on hold.

Bring it back to debate or at least say why it was abandoned, Roach recommended.

“There’s definitely a formula that can get us out of the quagmire on the fiscal side, and I would say that there is equal pressure, and there should be, on the Federal Reserve to do the same thing with zero interest rates,” Roach said.

“I think zero interest rates and QE are the time bomb that is really ticking.”

Fed officials, meanwhile, are sticking to their guns, arguing loose policies must stay in place until the labor market shows marked improvement.

“Our concern is to make sure our policies aren’t creating problems with market functioning,” Federal Reserve Bank of San Francisco President John William told The Wall Street Journal.

“In terms of how far you can go, I don’t think that we’re anywhere near any kind of limit to that in terms of our current policies, and I expect that to continue well into next year. I don’t think we’re getting close to a constraint in that.”

Editor's Note: Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

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