Does the Fed want more inflation?

”The expectation of further quantitative easing is already being priced into the market even though it hasn’t taken place. We’ve had a 50- to 65-basis-point [0.5 to 0.65 of a percentage point] decline in yields along the Treasury term structure.  When the Fed announces more quantitative easing, we might not see that much of a reaction in security prices.

Shouldn’t it boost other asset prices along with Treasuries?

There will be a spillover effect on other asset classes such mortgage securities, other asset-backed debt, corporate debt and even the stock market, lifting prices some.  Quantitative easing will also help in other respects.  When the Fed purchases Treasuries, that also puts downward pressure on the exchange value of the dollar, and upward pressure on commodity prices.

Is that a good thing or bad thing?

That depends on your outlook.  Certainly you can’t expect the chairman of the Fed to go around making speeches saying ‘hooray, we are depreciating the currency.’  Yet dollar weakness is a good thing as long as it is limited, controlled and gradual.  A currency decline helps exports become more competitive.  Rising commodity prices and more expensive import prices help fight deflationary forces.  Remember, the Fed has said inflation is below its mandated level at present.

A modest boost in inflation also lowers interest rates in real terms by narrowing the gap between nominal rates and underlying inflation.  The lower real rates are, the more borrowing and economic activity one can expect.  Just recognize how unique a position we are in right now.  It isn’t often that Fed policy involves inducing inflation rather than fighting it.”