There can be no better explanation than the one given by Friedman in his seminal paper, 'The Role of Monetary Policy', which came out in the American Economic Review in 1968. It would be worthwhile to note that Friedman's observation "What Monetary Policy Cannot Do- From the infinite world of negation, I have selected two limitations of monetary policy to discuss: (1) It cannot peg interest rates for more than very limited periods; (2) It cannot peg the rate of unemployment for more than very limited periods", shows the difference of the current policy objectives of central banks with what he believed monetary policy had limits to achieve. I reproduce below his explanation:

"Let the Fed set out to keep interest rates down. How will it try to do so? By buying securities. This raises their prices and lowers their yields. In the process, it also increases the quantity of reserves available to banks, hence the amount of bank credit, and, ultimately the total quantity of money. That is why central bankers in particular, and the financial community more broadly, generally believe that an increase in the quantity of money tends to lower interest rates. Academic economists accept the same conclusion, but for different reasons. They see, in their mind's eye, a negatively sloping liquidity preference schedule. How can people

be induced to hold a larger quantity of money? Only by bidding down interest rates. Both are right, up to a point. The initial impact of increasing the quantity of money at a faster rate than it has been increasing is to make interest rates lower for a time than they would otherwise have

been. But this is only the beginning of the process not the end. The more rapid rate of monetary growth will stimulate spending, both through the impact on investment of lower market interest rates and

through the impact on other spending and thereby relative prices of higher cash balances than are desired. But one man's spending is another man's income. Rising income will raise the liquidity preference schedule and the demand for loans; it may also raise prices, which

would reduce the real quantity of money. These three effects will reverse the initial downward pressure on interest rates fairly promptly, say, in something less than a year. Together they will tend, after a somewhat longer interval, say, a year or two, to return interest rates to the level they would otherwise have had. Indeed, given the tendency for the economy to overreact, they are highly likely to raise interest rates temporarily beyond that level, setting in motion a cyclical adjustment process."



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There is one more potent reason that the credit boom driven by Fed QE can run up to a point as the collateral 'transformation' process hits a wall as explained by Jeremy Stein in his speech recently.

