Quantitative easing has begun

November 14, 2008

johnkemp3– John Kemp is a Reuters columnist. The views expressed are his own –

Quietly, without fanfare, the Federal Reserve has turned on the printing presses.  The central bank is flooding the market with enough excess liquidity to refloat the banking system — and hopes to generate an upturn in both economic activity and inflation in the next 12-18 months to prevent the economy falling into a prolonged slump.

Since the banking crisis intensified in September, the Fed has been rapidly expanding the credit side of its balance sheet, providing an ever-increasing array of facilities to support the financial system (repos, term auction credit, primary discount credit, broker-dealer credit, commercial paper funding, money market mutual fund liquidity and term securities lending).

Total credit extended by the central bank has surged from an average of $885 billion in the week ending August 27 to $2.198 trillion in the week ending November 12.  Credit extensions surged another $142 billion last week alone — mostly in form of increased term auction credit (+$114 billion) and other miscellaneous credits the central bank does not break out (+$41 billion).

Until fairly recently, the expansion on the asset side of the Fed’s balance sheet was matched by increased non-bank liabilities, mostly in the form of higher balances deposited by the US Treasury into its regular and special supplementary financing accounts at the central bank.

Since the Treasury was borrowing this money in the open market by issuing cash management bills, the impact of the Fed’s balance sheet expansion was being fully sterilized.

The Fed was providing liquidity in the narrow sense (helping commercial banks cover short-term funding problems arising from illiquid assets on their books) but not in the broader sense of inflating the money supply (money in circulation plus vault cash plus reserve balances).

But in the last three weeks, something very significant has happened. The non-bank part of the Fed’s liabilities has stopped expanding:  combined Treasury deposits with the Fed plus cash in circulation has actually fallen from $1.517 trillion in the week ending Oct 29 to $1.467 trillion in the week ending Nov 12.

Instead, the Fed’s increased lending to the financial system over the last two weeks (+$325 billion) has been matched by an increase in the volume of deposits the commercial banks are hold with the Fed (+$331 billion).

In other words, the Fed is now lending to the banks, which are now lending the funds back to the central bank.   The Fed is no longer supplying just narrow liquidity needed to enable the market to function.  It is now supplying excess funds (more than the banks need) which are being recycled back into the central bank.

The volume of reserve balances with the Fed, which had jumped from $8 billion at end Aug to $280 billion by mid Oct, has now surged again to a staggering $592 billion in the week ending Nov 12.
The Fed is now very deliberately supplying more liquidity than the banks need (or are willing to lend on to other banks, corporations or homeowners).  By paying a low but positive interest rate on these reserve balances, it can ensure that the federal funds rate remains above zero (currently about 35 basis points) even as it floods the banking system with excess funds.

There are several startling implications:

(1)  The central bank has successfully driven a wedge between interest rate policy (the target fed funds rate) and the quantity of money created (cash plus reserve balances).   This was the explicit aim, foreshadowed a recent paper by the Federal Reserve Bank of New York (http://www.ny.frb.org/research/EPR/08v14n2/0809keis.pdf).  The Fed is now free to expand bank reserves almost without limit while maintaining the fed funds target (at least very loosely).

(2)  The Fed’s focus has now shifted from easing the interest rate to increasing the quantity of money, and the aim of supplying funds is no longer to ease concerns about narrow liquidity but to increase the overall money supply, thereby easing concern about the stability of the banks, while hoping to engineer an eventual upturn in lending, activity and (whisper it quietly) inflation.

This is precisely the radical strategy adopted by the Bank of Japan in the late 1990s and early part of the current decade, when it was described as “quantitative easing”.  Fed Chairman Ben Bernanke, a keen student of liquidity traps during the Great Depression and Japan’s decade long banking and economic slump, threatened some time ago that the Fed could always increase the quantity of money by manipulating the size and composition of its balance sheet.

In a 2004 paper Bernanke noted: “nothing prevents a central bank from switching its focus from the price of reserves to the quantity or growth of reserves. When stated in terms of quantities, it becomes apparent that even if the price of reserves (the federal funds rate) becomes pinned at zero, the central bank can still expand the quantity of reserves. That is, reserves can be increased beyond the level required to hold the overnight rate at zero–a policy sometimes referred to as ‘quantitative easing.’ Some evidence exists that quantitative easing can stimulate the economy even when interest rates are near zero; see, for example, Christina Romer’s (1992) discussion of the effects of increases in the money supply during the Great Depression in the United States.”

Bernanke argues that quantitative easing may affect the economy through at least three channels:

(1)  Large increases in the money supply will lead investors to rebalance portfolios, reducing yields on other non-money assets, stimulating investment,consumption and other economic activity.

(2)  Setting a high level of reserves and committing to maintain it until certain (economic) conditions have been fulfilled is an alternative and perhaps more visible and credible way to stimulate growth and promising to maintain a low interest rate.

(3)  By expanding its balance sheet and replacing public holdings of interest-bearing government debt with non-interest bearing (or very low interest) money and reserves, the central bank may attempt to hold down yields on a range of government securities, making borrowing cheaper, and cutting the costs of an expansionary fiscal policy. The strategy works if and only if the central bank can pre-commit not to reverse the quantitative easing policy for some considerable period and until certain conditions have been met.

Bernanke went on to note: “The forms of monetary stimulus described above can be used once the overnight rate has already been driven to zero or as a way of driving the overnight rate to zero.
However, a central bank might choose to rely on these alternative policies while maintaining the overnight rate somewhat above zero.”

Moreover, alternative monetary policies such as quantitative easing could enable the central bank to avoid the problem that nominal interest rates cannot readily be cut below zero:   “A quite different argument for engaging in alternative monetary policies before lowering the overnight rate all the way to zero is that the public might interpret a zero instrument rate as evidence that the central bank has “run out of ammunition.”

That is, low rates risk fostering the misimpression that monetary policy is ineffective. As we have stressed, that would indeed be a misimpression, as the central bank has means of providing monetary stimulus other than the conventional measure of lowering the overnight nominal interest rate”.   Since the middle of October, the Federal Reserve has begun to put precisely this strategy into practice.

Quantitative easing has begun.

Bernanke once threatened to send in the monetary helicopters if that was necessary to avoid deflation and a renewed Great Depression. The massive surge in bank reserves in the past fortnight suggests the helicopters have now been scrambled and the strategy is being put to the test.

30 comments

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To extend the metaphor, how does the flooding work, if the recipients keep pumping the money back into the central reservoir?

Posted by Peter Caritato | Report as abusive

Thank goodness the Fed is trying to fix the problems it created.

When 3 billion people are living on under $2.50/day, excess factory space and labor are pandemic, and technology obviates commodities (think wireless for copper, solar for oil, skyscrapers for land), why anyone would constrain economic growth via constrictive monetary policy and 18 straight Fed funds hikes in 2004-2006 is beyond me.

Hopefully, this next time they won’t create the same global financial crises once the global economy heat up again.

How did that work out for japan ?

Uhhh I think they just put in a 27 year low, double bottom, i.e., all the pump came off..

Good luck with at fed pump bullshit.

DAMN IF YOU DO, DAMN IF YOU DON’T

Posted by TWINKLE | Report as abusive

I have to disagree with the author’s analysis about non-bank liabilities “sterilizing” the effects of the Fed expanding its balance sheet.

No matter what the Fed puts on its books, it is injecting more inflation into the economy, which usually ends up inside the banking system somewhere. Thus the idea that expanding non-bank liabilities sterilizes the effects of a loose-monetary policy is just not true.

Here is the situation: the system is bankrupt. Thus the need to inflate. All the Fed has up its sleeve is a printing press, to print up more of its notes which are nothing but debt instruments themselves. All the Fed can do is ensure that people will get dollars, no matter how worthless they become.

That the Fed is becoming the lender of FIRST resort for so much of the economy now tells us that there is a paucity of savings and that there are a lot of bankrupt entities. Of course, there is no good reason for good institutions to lend to bad ones. The bad ones can’t lend to the good ones. You have to let the market shake itself out. The Fed is not doing that.

The loan market is incapable of supporting the biggest sub-prime borrower of all (i.e., the US government), by buying Treasuries. Thus the Fed is injecting its inflation straight into the banks. You watch. Now the banks will buy up Treasuries to finance the government’s spending orgy. This money the government spends will stay inside of the banking system. No matter what kind of liabilites the Fed has on its balance sheet, the Fed’s recent orgy is bad enough and there is no way to “sterilize” any of this. It is going to get even worse when the Fed buys up the Treasuries that the banking system can now purchase. Inflationary holocaust.

By increasing the money supply – a short-term measure – we are only handling symptoms of a broader problem. We are perpetuating the failure of companies to shift their financing structure to the longterm. Assume company A competes with company B. Company A makes worthless junk. Company B makes innovative products that will help us be a productive nation. By supporting the prevailing financing structure, we make it possible for company A to continue competing with B. Because any business can keep things running when money is practically free. Moreover, company B loses the incentive to do things any differently.

Methane has the potential to be a renewable resource. I want a methane-powered automobile. I will never get one because we are supporting the commercial paper floats of worthless automotive operations. If people go my way, there would be new factories built, new fueling stations and a huge expansion of skilled tradespeople. We would be building the foundation of a stronger future independent of Middle-east oil. But nominal thinkers want to expand the money supply. Great we’ve expanded it. It’s been expanding for years. Isn’t the world a whole lot nicer now. We have economic stability, powerful growth into new markets and employment opportunities, right. Good work.

Posted by Don | Report as abusive

It is all manipulated, we live in a world similar to the movie “The Truman Show”…the Jim Carrey movie. The dollar should be dropping like a rock, but let’s prop it up until Jan. 20th so the new POTUS will take the blame. The government knows the 3 billion actors taking part in this high school musical are stupid and really only care if American Idol gets cancelled or Britney flashes her crotch again and again and again. Call up the new girl, “We need new crotch shots to take the attention off our bailout screw-up.”

Why is it not all over the mainstream media how COMEX & CFTC have manipulated the price of silver SINCE the Hunt bros tried… I guess the Hunts just planted the idea in their heads, but the difference is this time it is similar to cops policing themselves…you trust that to happen in a dark alley or dark backroad…didn’t think so.

Now articles are up saying world leaders won’t shake Bush’s hand, well worldwide the leaders have been sitting on their own thumbs, so I guess they all have to hide their STINKY hands!!

Posted by Rusty Shakleford | Report as abusive

I believe that the Fed is a lot more worried than they are letting on. While their words say that they are containing the situation, their actions show desperation.

http://www.plusev.ca/how-worried-is-the- fed/

None on these monetary problems will be solved unless and until the Constitution is again obeyed:
The Constitution’s Money Clauses [Bracketed text is not verbatim.]

[Article I,] Section. 8.[Clause 1] The Congress shall have the Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States but all Duties, Imposts and Excises shall be uniform throughout the United States;

[ Article I, Section 8, Clause 2] To borrow Money on the credit of the United States;

[ Article I, Section 8, Clause 5] To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures;

[ Article I, Section 8, Clause 6] To provide for the Punishment of counterfeiting the Securities and current Coin of the United States;

[Article I ,Section 10, Further conditions and prohibitions:]
Section. 10. [Cl.1] No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility. [The careful reader will note that "Money" is not credit, it is Lawful Coin of silver or gold. JL]

Dear Reader,
After you attempt to square the above never amended text with the Federal Reserve Act of 1913; Please also be aware that, except for Rights reserved to the States in the 9th and 10th Amendments, governments have no rights, they have only duties, obligations & limited powers.

Are we all not Kings, sovereigns of our own?. The Federal Reserve? Really? you attend to them like an audience at a game. Try not to have your feeling hurt when Yahweh puts all on bended knee.

Life is not about this. If you honor this presence you corrupt your own. Economics for this great land have passed. Look not for your riches in this place.

Let the presses roll, there is only one bank. Go figure

Posted by William the King | Report as abusive

Hey, trickle-down works. Just ask all the rich new-money punks who run AIG, Congress, the White House, etc.

Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it.

http://www.federalreserve.gov/BOARDDOCS/ SPEECHES/2002/20021108/default.htm

Bernanke admits the feds caused the great depression.

Posted by Linh | Report as abusive

Yeah, Ben Bernanke made the wrong confession, though. Bernanke says the Federal Reserve caused the Great Depression by having not inflated enough. That is the opposite of the truth. And the more Bernanke inflates today, the worse the problem is going to become. The government can’t stop a recession, but it sure can make one a whole lot worse.

And when you start seeing a deflation hysteria throughout the media, know that inflation is looming on the horizon.

The fact that this article and comments are available for all to read is not going to help the FED on their project; likely most folks will be repelled and angered by it. In a country that finances itself in this fashion, would any reasonable investor advance money or invest in it? The FED can pump all it wants to; I’m not going to buy their program or invest in anything associated with it, i.e., banks. The problem with all these gov’t and business leaders is they just don’t get it! The public is getting too smart to be fooled by their Crazy Town schemes.

Fully agreed the Fed’s assets & liabilities (H.3) is very odd. I’m not sure how “central bank” is different from “Fed”. But that is a sylistic nit.

What appears to be happening is that nearly all commercial banks have suffered bankrupting losses from subprime and other loans non-performance. Recognizing the failures would bankrupt the FDIC (many times over) and worse, totally shutdown the payments clearing system. So the banks cannot be allowed to fail.

The Fed has stepped up to the plate in progressive ways taking in crud as collateral for loans, and the Treasury has extorted some shares. All of these reCAPITALIZE the banks and haul them back from bankruptcy. Somewhat confusingly, the Fed’s payments also appear as RESERVES and could be used to support additional deposits.

Like in mountaineering, the problem comes on the backside. Will the Feds be able to control the banks once they’ve stopped hurting from their losses? Especially since they want more lending? A precise pull-out is unlikely

Posted by Robert in Houston | Report as abusive

Iron Law of Economics: In Order to Consume, you must First Produce. The problem is not consumption, the problem is production. Find out why no one wants to produce in the USA and fix those problems. That means reform of our legal system (punitive damages in a Civil Court?)., reform our regulatory system (get rid of OSHA and EPA), reform our labor laws, slash taxes, establish a solid currency based on gold, replace the income tax with a sales tax, get rid of the IRS, establish private banking, reform our accounting standards, and balance budgets. On top of that, long term go to school vouchers and let public schools compete. Paper is not wealth and printing paper is not production. This will fail.

Posted by JamesD | Report as abusive

Soooo…why isn’t gold going through the roof if this is the case?

Posted by kjm | Report as abusive

Fix the problem with more of the same problem. This is savage foolery by devious and delusional men in charge of the Federal Reserve and US Treasury whose actions bespeak of obedient servitude to Bush and his Ship Of Greedy Rich Fools. As some man hereon said, we are not allowed by law to create these valueless dollars. What is this ploy, where they can print this “fools currency” and then lend it to banks and then in turn borrow it back from the same banks, ad infinitum; a hot potato of empty debt inflated on each subsequent cycle of a shill game. And they call that, prudent management? What an ugly game to perpertate on us all. The consequences are only postponed until one or more of the players decide they no longer want to be participate, and the masquerade is revealed and the game breaks down.

This is no longer a Free Market system. Let the system collapse to where it can find it’s true and natural equilbrium. Otherwise, convert to Socialism. I can’t help but feel I’m caught in an ugly web of deception and/or stupidity, with this half socialism/half capitalism model they’ve contrived to protect me from the horror of lower prices. How can deflation be such a horrible thing? Why is never ending inflation preferable? Why is irresponsiblity rewarded? How can a prudent and sane man not be disgusted by it? They are either conciously or unconciously protecting their own wealth and their narcissistic illusion that appeasing the Credit God’s endless appetite is the only correct policy for global market health. I say conciously or unconciously, because I find incredulous that anyone with so much power can be so dangerously stupid.

Posted by RJAY | Report as abusive

The Fed needs to get around the liquidity trap problem
in which banks hold excess reserves rather than making
loans; otherwise, they are caught in the old problem
of the mid-thirties of “pushing on a string.”
The can fix the problem by CHARGING interest on
*excess* reserves.

Posted by fred clancey | Report as abusive

Quantitative eassing, if assisted by American innovation and courage will stimulate the economy and salvage the currency. Bernake has a good clean vision.

Posted by paul gamberg | Report as abusive

They will replace a deflationary depression with an inflationary depression. If I was out of work I would rather have prices going down. If they are “successful” the next down turn will be harder. With our current political and monetary system there is no way the real economy can escape a down turn with a normal market correction. The Fed and the government created the problem with easy money and loose lending. Can they escape doing the same thing?

Posted by david moore | Report as abusive

Whatever. Theory is theory and practice is practice. Greenspan, with his blind belief in Ayn Randian nonsense, created this crisis. Bernanke, with his academic theoretical nonsense, is going to drive this down much farther.

I ask two basic questions: (1) Who would the banks lend to? and (2) What will be the money used for, i.e., to what productive means?

If we can’t answer these two questions, no amount money would ease the problem. On the other hand, it may lead to hyperinflation and treasury might need to print new $100 Billion dollar currency notes like Zimbabwe.

Posted by JC | Report as abusive

Quantitive Easying is a term that distorts the truth.
Inflation = Money Supply. The higher the inflation, the less our money is worth.

How in the world, can we solve the problems of inflation (the increase in the supply of money) with more inflation? The “Fed” wants to print more money, because more money means more loans. More loans means more interest. More interest causes us to borrower more money to repay the existing loans. It is a game of monopoly and we(tax payers) are losing! Under the Federal Reserve System, perpetual debt is garunteed! Give the issuing power back to congress where it rightfully belongs!

How about letting the wildly inflated asset prices correct to historical levels of affordability before we prime the pump? Along the way, let the banks with good business models take the place of those with bad.

Bernanke spent his entire life studying books on how to prevent deflation. He lived in a splendid fantasy land and was validated beyond belief for his efforts. But when it came to real life, he proved that he hasn’t a clue on how to prevent deflation.

Internet bloggers without a formal education in economics had been screaming for years that we were headed for a massive housing correction accompanied by economic contraction. Meanwhile, Bernanke was confidently stating we didn’t have anything to be concerned about. Now that it’s too late to provide any real preventative measures, Bernanke is treating the symptoms instead of the cause. But the rat sheep just close their eyes and say, “he’s an expert, let him be.” IMO, to be an expert on something, you have to have “real life” experience. Reading books and writing papers reciting historical events is meaningless when it comes to acting in the real world. Einstein correctly pointed out that “imagination is more important than knowledge.”

Bernanke has a great deal of knowledge, and very little imagination. So what good is he?

Several commentators below make the over-simple assumption that printing money necessarily results in inflation. First, the evidence: Japan engaged in quantitative easing with printed money, and big time. Result? Practically nothing. No effect on inflation and no effect on anything else. Second, the theory.

One theoretical reason why Q.E. has little effect is that securities are viewed by their owners as savings (i.e. stuff they have no intention of spending). If government induces savers to convert part of their savings from securities to cash, the cash will not get spent: it will get dumped in a deposit account. Indeed, a proportion of Japanese security owners ran out and bought foreign securities when their own (Japanese) securities were converted to cash.

Q.E. seems justifiable if its purpose is to relieve banks of enough of their toxic assets to prevent a banking collapse. As to using Q.E. to drive down long term interest rates, this seems questionable. We all know that if governments’ attempts to rectify the recession result in excess inflation in two years time, governments will take a variety of deflationary measures, like RAISING interest rates. If I were offered a variable rate mortgage starting at around 0%, I wouldn’t run out and buy a mansion. And if I were a banker, I wouldn’t offer anyone a loan for 10 years at 0%.

I’m confused.

The whole issue of quantitative easing appears to be nothing other than inflating the money supply as well as manipulating the manner in which finanancial/monetary accounting is presented by the Feds and the Central Banking system . . . all for the sake of putting Humpty Dumpty (the former US economic lifestyle)
back together again; the way it was before deleveraging appeared within the global economy.

Observation and commentaries reflect quantitative easing in Japan did not jubilantly yield the desired outcome. But it could be argued the strategy did work in the manner it was designed . . . resulting in the large economic component of Japanese end users, the masses, continuing their customary frugal way of life . . . being ‘savers’, not spenders.

Understandably, the anxious, opinionated jury is not even close in accurately determining whether quantitative easing will provide a desirable end result in the US because the strategy is just beginning to being implemented. But the projected outcome could be successful – assuming, of course, the desired outcome is having the abundant supply of newly created monies being efficiently and effectively channeled to the large economic component of American end users, the masses, going back to their habitual lifestyle of spending for immediate gratification and committing to long term debt with a fair number of bankruptcy filings.

What a huge bet our financial power players are making by implementing such a game plan strategy; for not only is the outcome dependent upon the path of newly printed money, from beginning to end, they (the financial power players) will be hampered to affectively control the end result of implementing quantitative easing due to the inevitable, usually counterproductive wild card being injected along the way by the unmeasureable participation of the political class..

Maybe I’m not so confused after all . . . not only is change inevitable, life IS a gamble.

Posted by rbblum | Report as abusive

If my memory serves me correctly the words ‘resort to’ and ‘printing money’ have an historic liaison somewhere in thirties Germany.

Posted by John Peasnall | Report as abusive

So let me get this straight…using credit card to pay up another credit card is insanity, but borrowing more money to pay up for the excess of printed money which caused inflation is an asnwer? I am so confused that i don’t even know where to go to clear my mind anymore. The fed, the central banks, and all its staff members are already free people because they have the power to decide to make money out of nothing, but we don’t? I think that’s a double standard. It’s like, canadian or american soldiers can go to war and kill innocent people and not be condemned for it, but if they kill an innocent person or a lying devious politician, banker, economist one gets the maximum sentence, lmfao!!! This is just hilarious

Posted by lucivaldo | Report as abusive

How far are the FED prepared to go with the value of the Dollar? Have they any contingency plan if there is a sale on the Dollar? What do they determine to be long enough at this ploy and how long will the pullback period be. Are they going to indicate when this will start? They have to outline the precautions.

Posted by Donal Jackson | Report as abusive

Quantitative easing whereby newly printed notes are handed over to banks in the expectation that bank lending will be revived does nothing to solve the main problem of banking namely defaulting borrowers. The fiscal solution to defaulting borrowers involves giving an annual $1500 housing benefit to all United States citizens in reduction of their toxic bank overdrafts where appropriate, these toxic debts will then cease to be toxic.

Posted by Peter L. Griffiths | Report as abusive