The Fed has come in for a surprising amount of criticism since its decision in the fall of 2010 to launch a new round of monetary easing — Quantitative Easing 2. Ben Bernanke and his colleagues are right not to give in to these attacks.
Critiques seem to be of four sorts. (Some are mutually exclusive.)
1) “QE is weird.” Quantitative Easing entails the central bank buying a somewhat wider range of securities than the traditional short-term Treasury bills that are the usual focus of the Fed’s open market operations. This has been a bold strategy, which nobody would have predicted 3 or 4 years ago. But it has been appropriate to the equally unexpected financial crisis and recession. Some who find QE alarmingly non-standard may not realize that other central banks do this sort of thing, and that the US authorities themselves did it in the more distant past. It is amusing to recall that when Ben Bernanke was first appointed Chairman, some reacted “He is a fine economist, but he doesn’t have the market experience of a Wall Street type.” The irony is that nobody who had spent his or her career on Wall Street would have had the relevant experience to deal with the shocks of the last three years, since none of them were there in the 1930s. But as an economic historian, Bernanke had just the broader perspective that was needed. Thank heaven he did.
Everyone is looking for someone to blame for high prices of oil and other mineral and agricultural commodities. Speculators (among others) are high on the list, followed by the Federal Reserve. While I don’t think blame is necessarily the right concept here, I have been arguing that low real interest rates have worked to raise real commodity prices through a number of channels. Each of these channels could be called “speculation,” if speculation is defined as behavior based on expectations of future prices.
Fed Vice Chairman Donald L. Kohn in a speech yesterday, addressed a theory to which I am partial: the theory that low real interest rates have been a factor behind the continued rise in prices of agricultural and mineral commodities, including oil, over the last year.
The relevant excerpt: “Some observers have questioned whether the news on fundamentals affecting supply and demand in commodities markets has been sufficient to justify the sharp price increases in recent months. Some of these commentators have cited the actions of the Federal Reserve in reducing interest rates as an important consideration boosting commodity prices. To be sure, commodity prices did rise as interest rates fell. However, for many commodities, inventories have fallen to all-time lows, a development that casts doubt on the premise that speculative demand boosted by low interest rates has pushed prices above levels that would be consistent with the fundamentals of supply and demand. As interest rates in the United States fell relative to those abroad, the dollar declined, which could have boosted the prices of commodities commonly priced in dollars by reducing their cost in terms of other currencies, hence raising the amount demanded by people using those currencies. But the prices of commodities have risen substantially in terms of all currencies, not just the dollar. In sum, lower interest rates and the reduced foreign exchange value of the dollar may have played a role in the rise in the prices of oil and other commodities, but it probably has been a small one.” (Speech at the National Conference on Public Employee Retirement Systems, New Orleans, Louisiana, May 20, 2008).
If strong economic growth is not the explanation for the large increases since 2001 in prices of virtually all mineral and agricultural commodities, then what is? One wouldn’t want to try to reduce commodity markets to a single factor, nor to claim proof of any theory by a single data point. Nevertheless, the developments of the last six months provided added support for a theory I have long favored: real interest rates are an important determinant of real commodity prices. High interest rates reduce the demand for storable commodities, or increase the supply, through a variety of channels: