Sunday, September 27, 2009
As the first chart shows, the Fed has continued to practice "quantitative easing" to the max, as of the most recent data (Sep. 23). The monetary base today is essentially as big as it's ever been. The second chart, which comes to us courtesy of the Wall Street Journal, shows what the Fed has been buying in order to expand the monetary base. As the chart shows, the Fed has been gradually winding down things like TALF, Commercial Paper Facilities, and Central Bank liquidity swaps, as it has been gradually expanding its holdings of Mortgage-backed Securities, Agencies and Treasuries.
Interestingly, Treasury holdings today are almost the same as they were in late 2007. They fell last year as the Fed frantically sought to satisfy the world's demand for Treasury securities. When its holdings of Treasuries became seriously depleted, quantitative easing became the only remaining remedy. By the looks of things (a weak dollar, $1000 gold, rising commodity prices, and an expanding economy) they have done at least what the market was asking for, if not more.
This massive expansion of the monetary base, fueled these days by direct Fed purchases of Treasury, Agency, and MBS, remains the most potent argument in favor of a significant rise in inflation in coming years. That it has not yet shown up as higher measured inflation is probably due to the long lags that occur between monetary policy actions and when they finally impact the economy. Nevertheless, these two charts are among the most important things to keep an eye on.
Many, including most Fed governors, fear that an early reversal of quantitative easing, which would undoubtedly require higher short-term interest rates, might jeopardize the economy's nascent recovery. I think it makes more sense to worry about what might happen if the Fed waits too long. I seriously doubt that this economy is so fragile that it can't support short-term interest rates of at least 2-3%. I really worry that an inflationary error from the Fed at this point, which would weaken the dollar and undermine confidence in the U.S. economy, would do far more damage. Far better to pursue a path that builds confidence in the strength of the dollar, rather than gambling everything to boost the economy. Monetary policy was never designed to be a tool for raising or lowering the economy's growth rate.
Posted by Scott Grannis at 10:56 PM