Quantitative easing is not a sustainable policy. While it was justified during a time of crisis when the threat of destructive deflation loomed, its continuation can no longer be rationalized. Even in the context of sluggish growth, it is not appropriate. Should QE2 be extended or replaced by QE3, there will be growing concern that QE is being used to monetize the federal debt. Those concerns would be reflected via foreign exchange rates, interest rates (risk premia) as appetite for Treasury securities erodes (especially if Treasury yields were persistently < than inflation), and rising inflation despite considerable macroeconomic slack. The credibility of the Fed's commitment to price stability would also be damaged. I suspect that the Fed will not renew QE2 and will gradually begin to pare back its extraordinary measures down the road (recent Fed minutes hint at just such a prospect). Still, real risks remain long-term, especially if the fiscal imbalances are not addressed. Many other countries have embarked on monetization in the face of enormous fiscal challenges. Such a prospect for the U.S. cannot be ruled out, especially if Congress took a more active role on trying to shape monetary policy.
For now, I have greater concern that progress toward credible policy changes will lag on the fiscal front, with fundamental political differences and positioning for political advantage in 2012 impeding progress on that front. The big policy decisions will likely be put off in an agreement to raise the debt ceiling, even if ambitious goals/targets are set forth to create the perception of a significant breakthrough. Concrete details, not the expression of ambitious goals, will provide the narrative as to whether the nation has embarked on credible fiscal consolidation.
