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Unintended Consequences

A rather new view on the effects of Quantitative Easing seems to emerge recently. This post at ZeroHedge offers a neat explanation of what may be the long-term result of QE. The author assumes that the income effect of low interest rates is larger than the substitution effect. It makes sense to me, but I have no idea what empirical findings could tell us about this.

We shouldn’t forget the Ricardian Equivalence, which could explain the weak consumption response to low interest rates. In that case, it wouldn’t be excessively low interest rates but the fact that the government issues so much more debt under these favorable (cheap) circumstances.

Either way, there are huge risks looming that QE will fail and that it will finally destroy our financial system. Furthermore, it encourages governments to accumulate huge amounts of debt, which, in a scenario of sudden reversal of interest rate policy, can bankrupt whole countries.

There isn’t much positive to say about QE. The problems that it is supposed to solve, weak housing markets, bankrupt banks, cannot be solved by QE. The only way to get rid of these problems is to let the housing market find its new equilibrium of supply and demand, wind down insolvent banks, and reform the financial system in such a way that banks (and their customers) are responsible for their own mistakes again.

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