Thursday, March 19, 2009

The Fed Finally Swings for the Fences

The Fed has finally decided to swing for the fences with monetary policy. It announced yesterday that moving forward it will purchase another $700 billion of agency mortgage-backed securities, $100 billion of agency debt, and $300 billion of long-term Treasury securities. Add this move to the already $1 trillion-plus expansion of the Fed's balance sheet since the beginning of the crisis and the almost 0% federal funds rate and we have a Fed that is finally pulling out the big guns. This latest action, however, is the Fed's boldest move yet and sends a clear message that we have only begun to see what unleashed unconventional monetary policy looks like in practice. So much for the view spouted by many observers that monetary policy is all tapped out.

Like Tyler Cowen, I wish that such a bold policy move would have been done from the start instead of the piecemeal approach the Fed has tried to date. It would have reduced the need for a large fiscal policy stimulus. I also wished the Fed would have unleashed unconventional monetary policy in a more explicit manner by stating some target for nominal GDP growth or inflation (with the first of the two choices being my preferred option). Still, this change in policy is a huge improvement and should make a difference.

While the Fed's new policies do raise the possibility of inflationary problems down the road, let us not forget why this move is needed: (1) nominal spending is crashing in the United States and (2) only unconventional monetary policy has been shown to fix such problems. For those who are highly concerned about the inflationary implication of the Fed's expanding balance sheet I would refer you to Nick Rowe's thoughts on the matter.

Update: See The Economist's discussion of this policy move.


  1. It sure looks like a slick way of transferring bank losses to the taxpayer via inflation....
    If you have your money in a CD, bank deposit, or dollar denominated assett, then prepare to be robbed.
    I fully understand we are in a deflationary spiral, caused by the desire of the market to liquidate bad debt, but printing money to rob a bunch of Peter's (common man) to pay a few Paul's (bankers) is not only bad economic policy it is not a moral policy.....

  2. TexanNavy:

    The Fed is attempting to stabilize nominal spending, something Hayek himself prescribed. Just like the economy can overshoot on the way up, it can also overshoot on the way down. Yes, the Fed contributed to the overshooting on the upside, but that does not mean it should not try to prevent the economy from free falling. If done successfully--a big if--this move will prevent more Peters from being adversely hit from the recession.

  3. I am not sure John Taylor is quite so happy with the Fed "swinging for the fences" as you appear to be - see his FT article today.
    It also is interesting that oil prices have gone up 40% since January. You may be aware that Jeff Frankel at Harvard has pushed the line that monetary expansion often feeds through to oil market.

  4. David,
    Thanks for the different look at Hayek. He, after all, was probably the most pragmatic of the Austrians.
    I agree we are in the frying pan now and there probably is no other way out than monetary creation, unless we want to crush "Peter" with his debts. (I have some of those too hehe)

    However, these Trillions created to absorb the bank losses will be transferred to the taxpayer eventually via inflation, mark my words.

    Of course Hayek and the Austrians also vehemently argued the Fed was the CAUSE of the monetary deflation (due to bank credit expansion and easy money) in the first place. So how could we possibly put any faith in them to know when to apply the monetary brakes, and if they do have the wisdom to do that, what do we think will happen to the economy when interest rates are driven up to squelch the inflations effect?

    The pain has to come someday, these guys are only prolonging the length of time of the pain.

  5. ECB--Yes, I saw Taylor's article. In in the interest of balance I should probably mention it in a post.

    TexanNavy--No doubt bad policies played a part in getting us here. And yes, it may be too much to ask of policymakers to get it right this time.