Tag Archives: monetary policy

With the Federal Reserve’s main policy tool, the Fed funds rate, past the point of diminishing returns (although the target rate is 1%, the actual rate has been well below that for weeks), there are more signs that the Fed is willing to use new tools to stimulate the economy. Fed Chairman Bernanke’s speech today spelled out quite clearly (no more Greenspan-speak here) what the plan is (emphasis added):

Although conventional interest rate policy is constrained by the fact that nominal interest rates cannot fall below zero, the second arrow in the Federal Reserve’s quiver–the provision of liquidity–remains effective. Indeed, there are several means by which the Fed could influence financial conditions through the use of its balance sheet, beyond expanding our lending to financial institutions. First, the Fed could purchase longer-term Treasury or agency securities on the open market in substantial quantities. This approach might influence the yields on these securities, thus helping to spur aggregate demand. Indeed, last week the Fed announced plans to purchase up to $100 billion in GSE debt and up to $500 billion in GSE mortgage-backed securities over the next few quarters. . . .

Second, the Federal Reserve can provide backstop liquidity not only to financial institutions but also directly to certain financial markets, as we have recently done for the commercial paper market. Such programs are promising because they sidestep banks and primary dealers to provide liquidity directly to borrowers or investors in key credit markets. In this spirit, the Federal Reserve and the Treasury jointly announced last week a facility that will lend against asset-backed securities collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration. . . .

Expanding the provision of liquidity leads also to further expansion of the balance sheet of the Federal Reserve. To avoid inflation in the long run and to allow short-term interest rates ultimately to return to normal levels, the Fed’s balance sheet will eventually have to be brought back to a more sustainable level. The FOMC will ensure that that is done in a timely way. However, that is an issue for the future; for now, the goal of policy must be to support financial markets and the economy.

There have been a number of articles in the last week on the shift toward quantitative easing, and in particular the fact that the Fed is no longer sterilizing all of its liquidity injections (compensating for them by selling Treasuries to suck up cash). Here’s one from FT Alphaville with some nice graphs.

In their Real Time Economics post a week ago, Simon and Peter argued that this is precisely what we need. However, opinions differ – some fear that the increased long-term risk of inflation outweighs the benefits of monetary stimulus now.

There was a new theme buried in today’s announcements about purchasing $600 billion in mortgage-backed assets $200 billion in assets backed by other debt including student loans, credit cards, car loans, and small business loans. The New York Times story included these two paragraphs (emphasis added):

The action by the Federal Reserve on buying mortgage-backed securities brings the full force of monetary policy to bear on the credit markets. Having already reduced the benchmark federal funds rate to just 1 percent, the central bank is now effectively using what economists call “quantitative easing” to reduce the costs of money.

Instead of trying to reduce overnight lending rates in the hope of influencing longer-term interest rates for things like mortgages, the Fed is directly subsidizing lower mortgage rates. It is doing so by printing unprecedented amounts of money, which would eventually create inflationary pressures if it were to continue unabated.

The Bloomberg article has a similar passage, indicating that this is a message the Fed is consciously putting out, while taking care to deny that they are trying to increase inflation (emphasis added)

The Fed won’t be removing cash from other parts of the financial system to make up for the purchases, government officials told reporters on a conference call. They rejected any comparison with Japan’s so-called quantitative easing effort to combat deflation, saying that the Fed’s objective is to buttress credit markets rather than ramp up money.

What does this mean? It looks like the Fed will be buying securities either by wiring cold, hard cash to sellers, or by increasing their account balances at the Fed itself, without simultaneously selling Treasuries (or asking the Treasury Department to issue new Treasuries) to sop up an equivalent amount of cash. This ordinarily would run the risk of increasing inflation, but with short-term prices falling, arguably a bit of inflation is just what we need, as Simon and Peter argued yesterday.

(If you found the last paragraph confusing, see my Federal Reserve for Beginners post.)

More economics bloggers trying to be funny: Free Exchange reported on today’s $800 billion worth of announcements and concluded with this sentence: “So, you know, hopefully that will work out.”