Sunday, January 29, 2012

Doves eat the hawks over monetary policy

The Fed's policy announcement of a 2% inflation target and guidance that rates will stay low through possibly 2014 tells us the doves have eaten the hawks of the Board of Governors. It could have been worse with another round of QE immediately taking effect, but it is clear that the Fed is willing to pre-announce that deflation will not happen. This should not be a surprise. It also should not be a surprise that 2% is the target given it has been the de facto target for inflation across the developed world. If we have a 2% inflation target and near zero rates, it locks in a negative real rate of interest for an extended period. 

What should investors do? Borrow more money and lever up the portfolio, yet it is not clear this is what we want for the macroeconomy. I thought we wanted consumers to save and reconstruct their balance sheet. A negative real rate means that pensions will be destroyed at a fixed rate of 2%. So let's redistribute wealth from savers to borrowers. Who knows where this is gong to take us. There will be greater distortion in the markets over the next two years.

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