The US is navigating tough economic times: while the economy is expanding, it is not growing fast enough to reduce very high levels of unemployment. Growth is likely to pick up, but only gradually, leaving considerable excess capacity in labour and product markets for some time to come. That excess capacity is likely to keep inflation well below the 1? to 2 per cent level Ben Bernanke, the chairman of the Federal Reserve, has identified as desirable.

In an action designed to improve the prospects for the economy, the Fed has announced a programme to expand its holdings of intermediate and long-term Treasury securities. This is intended to promote an easing in financial conditions, thereby boosting spending and promoting a return of inflation to a more desirable level. We discuss two of the risks that recent critics have been highlighting.

Will these purchases lead to much higher inflation? Even though the Fed’s balance sheet has been extraordinarily large for some time, intense competition in labour and product markets has driven underlying inflation to its lowest level in decades. With these conditions unlikely to disappear soon, inflation expectations and inflation itself could fall further, raising real interest rates and leading to more prolonged economic stagnation. Preventing such an outcome appears to have been a major objective of the Fed’s actions.