Monday, October 6, 2008

The Fed: We Are Going To Inflate Our Way Out of This Crisis

The Fed has clearly scared itself into an inflation printing mode.

This morning it announced that it will begin to pay interest on depository institutions' required and excess reserve balances. Consistent with this increased scope, the Federal Reserve is also substantially increasing the size of the Term Auction Facility (TAF) auctions, beginning with today’s auction of 84-day funds. In addition, the Fed said it and the Treasury Department are consulting with market participants on ways to provide additional support for term unsecured funding markets.

The Financial Services Regulatory Relief Act of 2006 originally authorized the Federal Reserve to begin paying interest on balances held by or on behalf of depository institutions beginning October 1, 2011. The recently enacted Emergency Economic Stabilization Act of 2008 (The Paulson 'Bailout' Plan)accelerated the effective date to October 1, 2008.

The interest rate paid on required reserve balances will be the average targeted federal funds rate established by the Federal Open Market Committee over each reserve maintenance period less 10 basis points. Paying interest on required reserve balances should essentially eliminate the opportunity cost of holding required reserves.

The rate paid on excess balances will be set initially as the lowest targeted federal funds rate for each reserve maintenance period less 75 basis points. Paying interest on excess balances should help to establish a lower bound on the federal funds rate

The Fed also announced that the sizes of both 28-day and 84-day Term Auction Facility (TAF) auctions will be boosted to $150 billion each, effective with the 84-day auction to be conducted Monday. These increases will eventually bring the amounts outstanding under the regular TAF program to $600 billion. In addition, the sizes of the two forward TAF auctions to be conducted in November to extend credit over year end have been increased to $150 billion each, so that $900 billion of TAF credit will potentially be outstanding over year end.

Translaton of all this: The Fed can and will print huge quantities of new money.

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