Last week, the Fed took monetary policy action by announcing that it would use maturing assets to purchase new longer term Treasuries. The move is meant to stimulate the economy by encouraging firms and individuals to take on more credit for long-term loans. But an op-ed by former Federal Reserve banker Gerald P. O'Driscoll Jr. argues that this action won't help. He says that the Fed is powerless under these circumstances, because it can't strengthen the balance sheets of companies and individuals:

The declines in home values, investor portfolios and 401(k) plans, and the uncertainties surrounding retirement plans, have all had a big impact. The solution lies in restoring balance sheets. For financial firms, that means raising capital. For consumers and businesses alike, that means saving more of their reduced incomes.

Yet public policy has focused almost exclusively on stimulating spending without much regard to why spending, especially consumption, has flagged. Until balance sheets (corporate and household) are restored, increased spending cannot be sustained.

In other words, it would be better monetary policy to stop penalizing savings and better fiscal policy to keep taxes low. Then, we would just have to wait things out.

Read the full story at the Wall Street Journal.

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