We are spiraling into a deflationary depression similar to that of the 1930's. From a monetary policy standpoint the goal is to combat deflation through reflation. Reflation basically means to halt the tide of deflation and get prices to stop dropping. Most people confuse it with inflation. For example:
- When FDR abandoned the gold standard he was trying to reflate the economy, which was suffering from staggering price collapses in the 1930's. He was accused of driving inflation. His accusers were wrong.
- When William Jennings Bryan spoke of the "Cross of Gold" in 1896 he was arguing to reflate the economy. In history he has gone down as a proponent of inflation. History is wrong.
Deflation is bad because when prices drop people slow their purchases in order to buy at a lower price tomorrow. The economy slows and a deflationary depression becomes a self-fulfilling action. That is why government action is needed to end the cycle in a timeframe that minimizes the amount of economically shattered lives.
What's the best way to reflate the economy? Print money.
Money Supply = Monetary Base x Velocity of Money
The velocity of money is how quickly a dollar bill changes hands. In an economic slowdown the velocity of money goes down (because you are waiting for tomorrow to make your purchases at a lower price) so the money supply contracts all by itself. By expanding the monetary base (printing money or the government purchasing bonds on the open market) you can keep the money supply flat despite a slowdown in the velocity of money. Ideally you want a gradual increase in the money supply in order to accomodate economic growth.
So the announcement that the Fed is buying $1 trillion worth of securities basically by printing money is a good thing. It is reflationary (it can't be inflationary in a deflationary downturn). The goal is to juice the economy and create jobs. That is our foremost concern. If the economy recovers we will need to take decisive action to keep inflation down - but first we need the economy to recover. Nobody said this was going to be easy.
There is another reason why printing money is good for jobs growth in our current environment. Printing money (increasing its supply) lowers its value. That makes U.S. goods cheaper relative to other countries. That will boost exports and domestic purchases of U.S. goods. Some good old fashioned dollar devaluation is exactly what we need to drive jobs growth. We don't want to devalue the dollar too quickly because we don't want to cripple the market for U.S. Treasuries (we have a lot of overseas friends buying them), but a gradual dollar devaluation is good for us.