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Robert C. Merton, in an article written for Pensions & Investments (pionline.com, "Monetary policy: It's all relative", April 16, 2015) observed "One of the goals behind quantitative easing in the U.S., Europe and even Japan has been to pursue the 'wealth effect'--pumping up the value of assets to make individuals richer, thus getting them to spend more and, thereby, prevent deflation. Furthermore, the belief that lower long-term interest rates leads to more investment has led the Federal Reserve, and now the European Central Bank, to depress long-term interest rates." He and his co-author, Arun Muralidhar, argue that "...while QE has increased absolute wealth, it has simultaneously lowered relative wealth for a large class of investors. ... Lower wealth means investors need to save more to improve their funded status, esp. where regulations are strict... and it results in less consumption and investment, and may not remove the deflationary overhang." Five years on, it is evident that the "deflationary overhang" was a remote risk. The original intent of QE justified its initial use, but its continued use is of doubtful effect. The composition of the Bank's asset portfolio indicating the surge in bonds and the decline in bill and repo holdings suggests that the Bank is focused on lowering, or keeping low, longer term interest rates (5 year - 10 year term debt), and this may be why residential investment has climbed so high while business investment as remained stationary, relative to historical levels. Residential investment responds to the mortgage rate, and repressed interest rates (yields) at the 5-year maturity bonds achieved through a change in the composition of assets acquired via QE may be an explanatory factor in the rapid increase in residential investment. If the Bank pulls back further in QE acquisitions of government bonds, then the practical effect will be an upward reset of mortgages rates and a decline in residential investment. Since residential investment does tend to crowd out other forms of investment, tapering QE sooner rather than later may improve investment in productive capacity somewhat, ceteris paribus, even as it reduces employment and lowers consumption spending. Steepen the yield curve to address Merton's and Muralidhar's concern over financial oppression, while leaving the over-night rate at its current low level to avoid raising the inflation rate higher (Fisher effect), might be the correct policy response.

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