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Washed Away on the QE2

Author: Benn Steil, Senior Fellow and Director of International Economics
January 4, 2011
Project Syndicate

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Imagine that you get in the shower, turn on the water, and nothing comes out. You call a plumber, who tells you that there are holes in the pipes, and that it will cost you $1,000 to repair it. You tell him to turn up the water pressure instead.

Sound sensible? Well, this is the logic behind the United States Federal Reserve's second round of “quantitative easing” (QE2), its strategy to keep flooding the money pipes until credit starts flowing freely again from banks to businesses.

You wouldn't expect this to work in your shower, and there is little reason to expect it to work in the commercial lending market. The credit-transmission mechanism in the US – and elsewhere – has been seriously damaged since 2007. Small and medium-size businesses in the US depend on small and medium-size banks for access to vital credit, yet too many of these banks remain zombies, unable to lend because their balance sheets are littered with bad commercial and real-estate loans from the boom years.

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