Wharton finance professor Jeremy Siegel argues that the second round of quantitative easing -- or QE2, the Fed's effort to purchase bonds in search of looser monetary policy -- is working because Treasury rates are rising:
Long-term Treasury rates are influenced positively by economic growth—which encourages consumers to borrow in anticipation of higher incomes and causes firms to seek funds to expand capacity—and by inflationary expectations. Long-term Treasury rates are affected negatively by risk aversion: Seeking a safe haven, investors pile into Treasury bonds, running up their prices and lowering their yields. ... The Fed's QE2 program has raised expectations of growth and inflation, sending long-term Treasury rates up. It has also lowered risk aversion, which implies rising long-term rates.
I made the graph above with one of the Terasury Department's new widgets, and it shows the increase beginning shortly after the Fed changed its policy in the days after the election. Basically, one of the problems in the economy is that there is not enough investment; too many people are holding cash or Treasuries rather than putting that money into the economy. By increasing inflation expectations, the Fed is creating an incentive to spend money now rather than waiting -- hopefully spurring growth, as Siegel argues. So far, we're seeing the results the Fed had hoped for, and if the tax deal ends up getting some fiscal stimulus into the economy, we'll finally have some bare-bones coordination between monetary and fiscal policy, and that's not bad news, either.
-- Tim Fernholz
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