In defense of QE: the Fed's 'whatever it takes' policy makes sense, warts and all.

• Author: Berry, John M.

Since the financial crisis struck in 2007, the Federal Reserve under Chairman Ben S. Bernanke has pursued a policy that can best be described as "whatever it takes." At almost every stage, there were complaints when the Fed took what even central bank officials labeled extraordinary actions.

When straightforward interest rate cuts, even large ones, in the central bank's target for overnight rates weren't powerful enough to unlock frozen financial markets, the Fed fashioned numerous new ways to feed money and credit into the economy, including creation of special lending facilities focused on specific problem areas, such as commercial paper. And once the overnight rate target was firmly stuck at the dreaded zero lower bound, officials began providing investors with ever more specific forms of guidance about the likely future path of interest rates. Words became a central policy tool.

In March, for instance, the latest iteration of that guidance told the public that only one of the nineteen Federal Open Market Committee participants expected the 00.25 percent target to be increased this year, while three said that should happen sometime in 2014, thirteen said in 2015, and one said not until 2016. Even at the end of 2015, fifteen of the nineteen expected the target would be 1.25 percent or less. In other words, unless the still-sluggish recovery unexpectedly gains legs, interest rates aren't going up much anytime soon. That information about the path of short-term rates also helped lower market expectations for longer-term rates.

Even more explicitly, in January the FOMC majority had linked a future increase in their overnight target to achieving both a jobless rate of 6.5 percent or less and an inflation rate no higher than 2.5 percent. In December, the latest number the committee had, the rate was 7.8 percent. It was the first time the Fed had ever set any sort of employment target related to its statutory responsibility of fostering "maximum employment." More recently, Bernanke and several other officials have made it clear that a drop in the jobless rate is not a trigger for an automatic rate increase but rather a threshold for considering one.

But what has really upset many of the Fed's critics is its decision last September to seek to drive longer-term interest rates down even further through large-scale purchases of Treasury and mortgage-backed securities. Since then, the Fed each month has been buying $45 billion worth of Treasuries and $40 billion worth of mortgage-backed securities, which over the course of a year would increase the Fed's balance sheet by more than $1 trillion. With that program underway, total Fed assets passed the $3.3 trillion mark.

As the Fed moved repeatedly to ease monetary policy even after the recession had ended, the main criticism was that the action would lead to high, even runaway inflation. Economist and Fed historian Allan Meltzer warned that it was not whether the policy would lead to high inflation but when.

Former Fed Vice Chairman Donald L. Kohn of the Brookings Institution said in an interview that reality has blunted the warnings about Fed policy generating high inflation. When Kohn retired from the Fed in mid-2010, in conversations he had with business and financial sector people the talk was "all about inflation and buy gold and the world going to hell in a hand basket." Now, four years into the recovery, those predictions have faded. "Inflation has been going down and inflation expectations have been stable or going down a little. So that line of attack has been defused by the facts," he said.

Inflation has been replaced by worries about financial stability, and in particular by fears of new asset price bubbles in stocks, bonds, housing...