by machinehead
This post is one in a series from respected guest commentators while Chris is at work on his new book. Many of you will recognize today’s author from his insightful comments that appear frequently across PeakProsperity.com. Enjoy!
Since early April, the yield on 10-year Treasury notes has dwindled from 4.0% to below 2.5% on August 24th. Meanwhile, the 12-month change in the Cleveland Fed’s median CPI has hovered feebly between 0.5% and 0.6% since March. These abnormally low interest and inflation rates are fanning fears of renewed GDP contraction, a plunge into price deflation, or both. Boardrooms and blogs are humming with rumors of a ‘QE II’ (Quantitative Easing II) program to counter a chilly deflationary dip.
One reason fears are so acute is that the Federal Reserve’s main policy tool, the overnight interest rate on Fed Funds, is flatlined at zero. Moreover, via ‘extraordinary measures’ beginning in September 2008, the Federal Reserve added some $1.4 trillion of securities, including $1.1 trillion of MBS (mortgage-backed securities), to its balance sheet in a stimulus bid. Yet despite these heroic efforts, economic leading indicators have turned weak this summer, as sinking Treasury yields add to the disquiet.
In its August meeting, the Federal Reserve downgraded its economic outlook, and backed away from plans to let its enlarged securities holdings run off as MBS mature. Instead, it committed to buying about $18 billion of Treasuries from mid-August through mid-September, mostly in the 2- to 10-year range, by reinvesting MBS principal payments. It also set a $2.05 trillion floor for its securities holdings — thus freezing ‘QE I’ in place (perhaps forever) and hinting that a larger ‘QE II’ could follow.
But if QE I isn’t working, what hope would QE II have of achieving its purpose in a fresh emergency? This paper discusses a faster-acting alternative, which is feasible within the existing statutory and institutional structure — namely, targeted purchases of international reserve assets instead of Treasury notes.
Papers published by central bankers place great weight on managing expectations. In Seven Faces of the Peril, James Bullard of the St.
by erik-t-2 
