This is not a boxing match within the scientific arena nor is it an episode from the popular British science fiction television series.
The Federal Reserve seemed to think that prescribing massive injections of liquidity to avert the kind of banking crisis that caused the Great Depression of the early 1930s (Friedman-style) and coupled with another course of running of massive fiscal deficits in excess of 12 percent of gross domestic product this year, and the issuance therefore of vast quantities of freshly minted bonds (Keynesian-style) will give the economy a double dosage of drugs to pull the patient out of E.R.
But there is a clear contradiction between these two approaches and the central bank is trying to have it both ways.
Question is : can we be a monetarist and a Keynesian simultaneously?
The aim of the monetarist policy is to keep interest rates down, to keep liquidity high, the effect of the Keynesian policy is to drive interest rates up.
However, both of them have the same objective of trying to stimulate demand:
A) Monetary easing increase the money supply and flows to a liquidity constrained economy and reduces the cost of borrowing, leading also to restoration of credit.
B) Fiscal stimulus from the government replaces the components of our economy that are falling sharply such as consumption, investment, construction, capital spending, inventories, exports etc. when economy is suffering not just from a lack of liquidity but also problems of solvency and a lack of credit.
Real concern is that lenders may start to grow dubious about the financial solvency of governments and that would lead to a fresh push for the interest rates to head north as we have observed in government bond yields this week. After all, $1.75 trillion is an awful lot of freshly minted treasuries to land on the bond market at a time of recession, and we don’t quite know who is going to buy them. It's certainly not going to be the Chinese. Maybe only the Fed can buy these freshly minted treasuries, and there is going to be, in the weeks and months ahead, a very painful tug-of-war between our monetary policy and our fiscal policy as the markets realize just what a vast quantity of bonds are going to have to be absorbed by the financial system this year. That will tend to drive the price of the bonds down, and drive up interest rates, which will also have an effect on mortgage rates, which is precisely what the central banks have been trying to avert.
Bottom-line: lock in your 2.5% mortgage rates for the next 10 years!
Eric Tan, London
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The US Government is forecasted to borrow $18,400bn, equivalent to half of all federal expenses and 13% of GDP. and according to the Congressional Budget Office, a further $10,000bn will need to be borrowed in the next decade ahead which will take the gross federal debt over 100% of GDP by 2017 (ignoring off balance sheet liabilities of the Social Security system). No wonder people of getting dubious of the solvency of governments.
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