The Fed, Sir Isaac Newton, and QE

In today's FT, Mohammed El-Erian discusses the PIGS’ (Portugal, Ireland, Greece, and Spain) resurgent credit spread problems*. Toward the end of his commentary, he references a phrase that all non economists should know as it helps in understanding the mind of the dismal scientists and the comments posted the other day re the US Fed’s thinking on the risks of a Japan style deflation taking hold in the US**. The phrase is "path dependency".

"The history of emerging economy crises also tells us that these worrisome dynamics are self-reinforcing, resulting in what economists call “path dependency”. Rather than snapping back to a better outcome, bad developments increase the probability that the next set will be even worse."

Newton To The Rescue

A path dependency that leads to a steady state equilibrium for inflation and interest rates (which is the central point of the chart posted on Wednesday**) is the great fear of the Fed. And in the mind of the Fed the only way out of that condition is to exert an external force on it, with that external force being QE. Or as Sir Isaac Newton advised: "Every object in a state of uniform motion tends to remain in that state of motion unless an external force is applied to it."

Push, Ben, push.

*"Irish crisis demands new EU response"
**scroll down to Wednesday's posting, "Why The Fed Believes QE2 Is Necessary"