Pump up the volume : ZIRP & QE

Here come the ZIRP little darling ...

As a former central banker, I cannot hold the pleasure of a short comment on that.

Yes, indeed the FED has gone as far as ZIRP (Zero Interest Rate Policy). It has also commited to QE (Quantitative Easing) which it has done already for some months by inflating its balance sheet in order to jump start the bankrupt US economy.

Let us be short. There are three questions that we can ask ourselves regarding the ZIRP/QE policy. I will try to bring my own answer to each question.

1. Did the FED has another choice ?
I would say Yes. Because once you committed to QE - which was arguably the case for the FED at least since the Lehman collapse - you are supposed to use every possible means to achieve that, including ZIRP.

2. Will it work ?
The answer is "it depends". Actually despite, a body of litterature on ZIRP/QE and a review of the Japanese experience, there is no evidence that QE works. It is a pure monetary - let's even say monetarist - bet. However, as we know since New Keynesian Economics became the mainstream of short term macroeconomic analysis, it "could work" precisely because it is based on an illusion, an artificially generated price increase that lifts supply and demand by avoiding deflation.

3. When will it produce any effects ?
Here comes the main issue. As Krugman and other economists pointed out, it can take years before ZIRP & QE produce their effects. It depends on the ability of the banking system to channel the extra liquidity to the economy. By all accounts, in 2009 banks will rather use the money to restructure their balance sheets and drop the remaining toxic waste they still hold.
To avoid these long delays, what is needed is a combination of ZIRP/QE with demand stimulation in the form of a massive fiscal package and a low dollar.


Bottom line : Was ZIRP necessary ? yes, it was. Will ZIRP work ? it could work but nothing is certain. Will ZIRP alone work ? clearly not.