The Fed’s New Round of Quantitative Easing Is Like Trying to Patch Leaking Pipes by Pumping in More Water
by George Washington
→ Washington’s Blog
Bernanke announced additional quantitative easing yesterday, primarily in the form of buying treasuries to monetize the U.S. debt.
Jeff Harding points out that those worried about deflation within the Fed won out over the scared-of-inflation camp:
The Fed Open Market Committee voted today to roll its holdings of maturing Fannie and Freddie debt into longer term Treasurys. This represents a significant change in Fed policy and it appears that the anti-deflationist wing of the Fed, led by James Bullard, president of the St. Louis Fed, won over the anti-inflationists led by Thomas Hoenig, president of the Kansas City Fed.
As I reported last week, there is a significant movement in the Fed, led by James Bullard, to increase its Open Market Operations purchases of Treasurys in order to prevent deflation. They see that money supply is decreasing and that zero interest rate policy (ZIRP) has been ineffective. In a groundbreaking paper just published by Bullard, he advocates the purchase of Treasury debt which is, in effect, a monetization of U.S. debt. They believe that such purchases, called “quantitative easing” is the only effective tool the Fed presently has to increase money supply.
This reveals that the Fed is very worried about deflation.
Presently (as of August 4) the Fed holds a total of $2.054 trillion of debt. Commencing last year and continuing through April of this year, the Fed bought $1.25 trillion of GSE debt (MBS of the government sponsored entities, Fannie Mae and Freddie Mac) and the balance consists of Treasury paper. They intend to keep their holdings at this level. According to a subsequent release today by the NY Fed, which carries out the Fed’s Open Market Operations, Treasury paper purchases will be “in the 2- to 10-year sectors of the nominal Treasury curve, although purchases will occur across the nominal Treasury and TIPS yield curves.”
While the initial impact of this new policy on the economy will be modest, it sets a precedent for the Fed to substantially increase its attempts to inflate the money supply as the economy declines.
Given that the Fed has until recently taken extraordinary measures to avoid inflation, this may be a major shift.
Tyler Durden notes:
BofA’s Jeffrey Rosenberg provides the breakdown of the total amount of securities that roll off (MBS, Agency and USTs) over the next 12 months: the total is $340 billion, including the $230 billion (and possibly more) in MBS. Alas, this means that on a straight line monthly basis (and the finally outcome will likely be far more jagged), there will be on average just under $30 billion a month in incremental 2-10 Year Treasury Purchases. As Joseph Abate said earlier, this is not nearly enough to be considered a new stimulus, and at best seeks to retain the status quo. What is notable is that BofA believes today’s action should have been priced into the market.
So is another round of quantitative easing the right prescription for the economy?