Tuesday, December 16, 2008

Fed Sets Target Rate at 0 to 0.25%--Will Buy Huge Quantities of Assets; Major Inflation Ahead

The Federal Open Market Committee announced that it will establish a target range for Federal Funds of 0 to 1/4 percent.

A lot of this is window dressing since the effective Fed Funds rate has already been trading around 0.15% for the last two weeks.

Further, as I have pointed out, since the Fed has started paying interest on reserves on balance at the Fed, the level of the Fed Funds rate is not as significant since the Fed can add as much reserves as it wants at given interest rate levels.

Indeed, it appears that it will add huge amounts of reserves. From today's Fed statement:

The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.
Unless the Treasury is going to be borrowing funds to put on deposit with the Fed, this means the Fed will be creating additional reserves when they buy these assets. Since the latest money supply numbers show three month annualized M2 money supply growing at 17%, it appears that Bernanke is clearly clueless as to the platform he is building for one of the greatest inflation bursts in the history of the United States.

Whoever is buying T-bills at near zero interest is in for a rude awakening, the inflation ahead is going to be fast and furious. It could start as early as January.

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