Why the Federal Reserve’s recent and probably future policy is very dangerous

- "Since Lehman’s bankruptcy, the Federal Reserve has been implementing an ultra-expansionary monetary policy (nearly zero interest rates and liquidity growth), which will probably be stepped up because of the problems facing the US economy."
- "This policy in reality has virtually only drawbacks:
1) it has no positive effects on the US economy, since it does not lead to any upturn in credit or any rise in asset prices, in particular because of the ongoing deleveraging;
2) it leads to the appearance of excessive liquidity being held in banks’ balance sheets, and other economic agents that will subsequently be able to turn into purchases of assets and result in bubbles in asset prices;
3) it leads to growth in global short-term debt in dollars, hence:
• a distortion in exchange rates (appreciation in the yen and the Swiss franc, etc.);
• foreign exchange risk-taking (borrowers in dollars, lenders in other currencies);
• interest rate risk-taking (borrowers in the near term, lenders in the long term)."
- "In all likelihood, US monetary policy will remain very expansionary for a long time. To curtail the risks stemming from this situation, possible solutions include:
1) restricting international capital flows, but this would be difficult and might be inefficient;
2) regulating (curbing):
• foreign exchange risk-taking by banks (borrowing in foreign currencies, lending in local currency);
• interest rate (duration gap) risk-taking by banks (borrowing in the near term, lending in the long term)."

Natixis Flash Economics 459 20100915

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