The Federal Reserve: Deficit Enabler

Even President Obama, the architect of our $1.4 trillion deficit, sees that it is a problem.  One indication is his call for a two-year pay freeze for federal workers.  (This seems like a tactical error, in that it will have hardly any actual effect on the deficit, and will antagonize federal workers, who would normally be part of his constituency.)  Another indication is the president’s formation of the Deficit Reduction Commission, which will be voting on its final recommendations soon.

How can we afford deficits of this magnitude?  One answer is that in the short run the Federal Reserve is enabling them.  The Fed’s recently-announced “Quantitative Easing” will buy $600 billion in Treasury securities, which is almost half the deficit, and by buying longer-term securities it will keep interest rates low, making the rapidly expanding national debt easier to afford in the short run, although more painful in the long run.  If Mr. Bernanke agrees with the president that we need to reduce the deficit, he’s not showing any tough love by facilitating all that government borrowing.

If the Fed weren’t engaged in this easy money policy, the Treasury would find it much more difficult to sell its debt, and the high cost of deficit finance would be more apparent.

For an absolutely hilarious explanation of the Fed’s quantitative easing policy, you really need to see this video.  I don’t know whether the video is as funny to plumbers as it is to economists, but all my economist friends love it.  (You’ve probably already seen it, as YouTube says it has been viewed more than 3 million times already.)  I don’t know who wrote the script (tell me if you do), but whoever the author is has a biting sense of humor, and deep knowledge of the facts.  If you are at all interested in these issues, this video is a must see!

Randall G. Holcombe is Research Fellow at the Independent Institute and DeVoe Moore Professor of Economics at Florida State University. His Independent books include Housing America: Building Out of a Crisis (edited with Benjamin Powell); and Writing Off Ideas: Taxation, Foundations, and Philanthropy in America .
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