Tuesday, February 2, 2010

Meltzer: Fed's exit strategy will fail

Professor Allan Meltzer wrote recently in the Journal ("The Fed's Anti-Inflation Exit Strategy Will Fail", Jan.28) that he is worried that banks will begin to draw down their $1 trillion in excess reserves at the Fed and begin to lend out the money, thus creating inflation. 

His concern would be valid if banks were in a condition to lend. In fact banks are currently capital-constrained, a condition that may worsen due to planned accounting and regulatory policy changes. Not only are banks not in a position to end, in fact bank balance sheets are shrinking and bank credit is contracting at a 5% annualized rate.

The risk is not inflation, but another dip into deflation once the Fed ends its quantitative easing policy at the end of March.

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