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Has the Fed entered a new policy regime?

By Neil Irwin

A lot of the chatter around yesterday's Federal Reserve policy statement latched onto the idea that we're in a new world for Fed policy, one in which it targets a size of the balance sheet as a major policy tool.

It's not a crazy conclusion to reach from yesterday's statement. The Fed is going to reinvest proceeds from maturing mortgage-related securities into Treasury bonds, essentially freezing its balance sheet at $2.054 trillion (excluding the portfolios that result from the Bear Stearns and AIG bailouts, which it intends to liquidate as quickly as market conditions allow).

Steve Liesman on CNBC yesterday even argued that we could now be in a world in which the Fed tweaks its target for the size of the Fed balance sheet at each meeting as a way to either heat up or cool down the economy--for example, if economic data is stronger than expected between now and the September meeting, the Fed could lower the balance sheet target to $1.75 trillion, or if the data is weak it could increase the balance sheet target to $2.25 trillion.

I don't think that's what the Fed had in mind. There's nothing special about the current $2.05 trillion level of the balance sheet; I doubt anyone on the FOMC would argue that that is somehow at a uniquely optimal level.

Rather, on Tuesday they faced this dilemma: The outlook for growth has softened in recent weeks and the risk of inflation diminished. Yet monetary was becoming less accommodative--because low interest rates are leading more people to refinance their mortgages, the securities in the Fed portfolio were being paid off even more quickly than they otherwise would have. Fed officials wanted to stop that process and keep monetary policy from tightening, and in the meantime signal to financial markets that they are on top of things and have policy tools remaining, should it come to that.

So they announced a freeze of the balance sheet at the more or less arbitrary level it stood at in early August. The big question in markets right now is what might change that, in other words, what is their reaction function?

My best guess is that the decision of whether to resume asset purchases and expand the balance sheet is binary, not linear. If growth truly appears to be stalling out, with second half GDP growth coming in somewhere south of 2 percent (forecasts are in the 3 percent plus range now), and/or year-over-year core inflation gets below about 0.8 percent, the Fed starts to talk about the big guns. If they pull the trigger on those guns, it would be an announcement of another asset purchase program in the hundreds of billions of dollars, primarily of Treasury bonds.

What they're not likely to do is do ongoing adjustments to their target for the balance sheet, raising or dropping their goal for balance sheet size based on the latest data (though that's what at least one FOMC member, James Bullard of the St. Louis Fed, would prefer). I base this in part on how they've done these things in the past--the previous installments of quantitative easing came in one-off announcements of very large numbers that are carried out over time. But more broadly, the exact impact of a larger balance sheet on economic growth and price levels is highly uncertain. It would be folly, many at the Fed would argue, to pretend that the tool is finely tuned enough to be constantly tweaking the size of the balance sheet in response to the latest data.

Quantitative easing is the sledgehammer of monetary policy, not a ball peen hammer. You don't know exactly where it will hit, or how much force it will carry.

By Neil Irwin  |  August 11, 2010; 8:00 AM ET
Categories:  Federal Reserve  
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All the Federal Reserve did was decide that the economy was too weak for them to begin the process of drawing back any of the money that they pumped into the financial system to keep it from collapsing. The Fed has been successful in the only activity they have any power to do. That is keeping interest rates at a low level. The weakness in the economy is not a function of rising interest rates. So there is really nothing the Federal Reserve can do to combat it. Instead, what they have done is signal that their current policies represent the new normal at least for some extended period of time. Buying Treasuries likely does provide some additional stability to government debt and more or less admits what should already have been the obvious reality. There is no real alternative to the Fed, one way or another, monetizing some the private debt that the governement assumed when it bailed out the financial system, Fannie Mae, and Freddie Mac.

Posted by: Anonymous | August 11, 2010 11:23 AM | Report abuse

"The Fed is able to pump money into the economy by buying bonds -- in effect, it creates money out of thin air and uses it to pay investors for the bonds."

Wow! A bald faced admission about the criminal practice of "fractional reserve lending" in the creation of our money. Here's how it works down at the FED.

The FED is a privately owned corporation consisting of about a dozen member Family Banks. Half of them are European, so our monetary policy is NOT controlled in America. The FED charges us fantastic sums to create, print and distribute absolutely worthless paper money called, "Federal Reserve Notes."

The Banks who own the Federal Reserve, create and print up 98% of all the money distributed.

For the results of a House Investigation into Banking in America and the FED, see : [ ] This investigation named a number of those Banking Families Here are their names, and others from other sources.

Rothschild Bank of London; Warburg Bank of Hamburg; Rothschild Bank of Berlin; Lehman Brothers of New York; Lazard Brothers of Paris; Kuhn Loeb Bank of New York; Israel Moses Seif Banks of Italy; Goldman, Sachs of New York; Warburg Bank of Amsterdam; Chase Manhattan Bank of New York (Rockefellers)

Federal Reserve Note dollars are created using a criminal moneylenders trick, at least 400 years old, called Fractional Reserve Lending. (see "Money As Debt" at : [ ] or read a short explanation at : [ ] Look for it on, or YouTube. Google has banned the site and will not send you there.

An example of Fractional Reserve Lending : The FED Family Banks "purchase" electronically 1 million dollars in Bonds from the Treasury. They are then allowed to print up 9 million more dollars of valueless money, and loan this out for REAL interest. OR buy other Banks with it. OR buy General Electric and General Motors with it, which they have actually done. Through proxies and "investment funds", they now own the majority of the biggest corporations in America. And they got them for FREE, buying them with valueless money, they printed up themselves, for the price of the paper.

Under the FED charter, no audit can ever be made. The names of the member family banks can never be revealed. The profit of the corporation, the interest on the (entirely fictional) national debt can never be taxed. It amounted to 172 Billion Dollars in 2007. With the Stimulus and Bailout it may reach 5 times that amount in 2010.

Please note that the Stimulus and the Bailout funds were both paid to the Banks who own the FED and printed up, out of thin air, by them. WE have been charged , for that fictional money, with real DEBT.

There be ZERO discussion about the FED's plan. We must discuss NOW, in this newspaper, closing the FED and returning money creation to the save America from this criminal institution.

Posted by: vcompton1 | August 11, 2010 5:01 PM | Report abuse

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