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Piggy Bank Watch

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James Hamilton writes,

Where did the Fed obtain the funds to make all these loans and later buy all this MBS? Mechanically, the Fed implements any of these operations simply by crediting new deposits to the account that the receiving party maintains with the Federal Reserve. You can think of those accounts as electronic credits that the bank could ask at any time to redeem in the form of green currency delivered in armored cars by the Fed to the bank. Because the Fed had no desire to deliver this quantity of currency, up until the fall of 2008 it essentially sterilized the new loans by selling off some of its holdings of Treasuries.

...If the purpose of holding the MBS is indeed to produce a monetary stimulus, and if the purpose of raising the interest rate paid on reserves is indeed to produce a monetary contraction, why would the Fed want to do both at the same time? And yet Bernanke made pretty clear that he has no plans to sell off the MBS, which would be the logical way to contract. Instead it sounds like the Fed basically intends to hold those MBS to maturity:

The Fed should be engaging in ordinary open market operations, which means buying Treasuries. The only reason to buy anything other than Treasuries would be if it ran out of Treasuries to buy and still could not meet its overall target--whether that target is for the money supply, nominal GDP, or some weighted average of inflation and unemployment.

When the Fed instead is selling Treasuries or paying interest on reserves in order to sterilize the effect of buying other stuff, it is not being a central bank. It is being a piggy bank.

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CATEGORIES: Monetary Policy

COMMENTS (4 to date)
Bob writes:

I would characterize it as the Fed playing at being a hedge fund.

I understand, though, why the Fed is loath to sell its MBS portfolio - just a hint of this could send prices down sharply, self-inflicting significant losses. Sort of like China's position in the Treasury market.

Mario Sanchez writes:

Exactly - the combination of massively-expanded balance sheet and interest on reserves is not intended to re-inflate the money supply or the economy (at least not directly). It is intended to recapitalize the banks. They could increase (or decrease) the combination of balance sheet size & interest paid on reserves in order to accelerate (or decelerate) the cash infusioin into the banks.

This is not Friedman's Helicopter Drop as much as it is a guided missile aimed at the balance sheets of troubled institutions.

ziel writes:

Sell its MBS portfolio?? Is that a joke? It's complete junk - how could they possibly sell it?

Joe Calhoun writes:

The entire credit easing program was about supporting Fannie Mae and Freddie Mac. It's fiscal policy disguised as monetary.

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