Will the Fed Have to Choose Between Economic and Finacial Stability?

Commentaries on economics and technology.
May 5 2013 7:15 AM

Is the Fed Blowing Bubbles?

If we exit QE3 too quickly, the economy will crash. Too slowly, and we’ll see a finance bubble.

(Continued from Page 1)

But if the Fed has only one effective instrument—interest rates—its two goals of economic and financial stability cannot be pursued simultaneously. Either the Fed pursues the first goal by keeping rates low for longer and normalizing them very slowly, in which case a huge credit and asset bubble would emerge in due course; or the Fed focuses on preventing financial instability and increases the policy rate much faster than weak growth and high unemployment would otherwise warrant, thereby halting an already-sluggish recovery.

The exit from the Fed’s QE and zero-interest-rate policies will be treacherous: Exiting too fast will crash the real economy, while exiting too slowly will first create a huge bubble and then crash the financial system. If the exit cannot be navigated successfully, a dovish Fed is more likely to blow bubbles.

This article was originally published by Project Syndicate. For more from Project Syndicate, visit their Web site and follow them on Twitter or Facebook.

Nouriel Roubini is chairman of Roubini Global Economics and professor of economics at New York University's Stern School of Business.