Thursday, September 13, 2012

Fed Launches New Round of Quantitative Easing



From the Fed statement:
To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month


From the Fed statement:
The Committee also will continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities.  These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year.

 Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Dennis P. Lockhart; Sandra Pianalto; Jerome H. Powell; Sarah Bloom Raskin; Jeremy C. Stein; Daniel K. Tarullo; John C. Williams; and Janet L. Yellen.  Voting against the action was Jeffrey M. Lacker, who opposed additional asset purchases and preferred to omit the description of the time period over which exceptionally low levels for the federal funds rate are likely to be warranted.


Minimizing the money multiplier effect to 2 (it can be as high as 9.5 relative to M2), the Fed activity will result in additional 240 billion dollars of new money printed. The question becomes, does this money enter the system or end up as excess reserves? If it ends up as excess reserves (that is banks just depositing the money back with Fed) it will have no impact. If the banks put it into the economy by loaning the money out, the impact will result, at a minimum, in a 9.6% annualized non-seasonally adjusted growth in the money supply (M2). This would be very significant and result in stock market strength and manipulated strength in generally followed economic data. It would also mean significant price inflation down the road.


  1. I'm wondering how you get the value of 340 billion in new money. How do you generally determine this figure from the announcement of around $40 billion a month in additional MBS purchases and what assumptions are you using as well? Thanks.

  2. I was using a multiplier of 2 on the money pumped in(in the old days pre-crisis and pre-Bernanke paying interest on excess reserves the multiplier relative to M2 was almost 100). I went back to make my point clearer in the post.

    1. Ok thanks, I had forgotten about the high levels of excess reserves since the financial crisis and the new policy of paying intereston those reserves. Just looked at the figures and they have become truly unprecedented in the last few years.

      What are some of the tools the Fed might be planning on using to deal with a possible large exodus of excess reserves? Pumping up that interest rate paid on them? Seems like a ticking time bomb.

      For anyone else that was interested:

  3. Re: Anonymous

    He's likely done a back of the envelope estimate of the money multiplier. Ballpark is normally 9-1 leverage for fractional reserve banks, but maybe he's seen numbers to put it at 8.5-1.

  4. Perhaps money created at this point works in the following manner, it *only* becomes excess reserves. As banks get paid interest on excess reserves, that interest payment is used as a form of social welfare for banks. As banks have not recovered yet, the Fed perceives them as needing more social welfare via these interest payments on excessive reserves. So the intent here might be to raise excess reserves.

    Once the fed has given them enough banks enough social welfare, and their balance sheets are patched up, the Fed can then raise rates and suck all this money out of the economy.

    If it turns out banks aren't cleaned up yet, just print more money – it will go into excess reserves, so there is no problem – more social welfare for banks.

    I'm not saying this will actually work or that it is sensible in any manner, but I think this might be what the Fed actually thinks it is doing.

    In fact, if the banks started to lend out some of the money, perhaps Bernanke would increase the interest rate that is paid on that money, to keep it from getting into the economy.

    Even if I am right, I still find this all very harebrained and dangerous. However, figuring out exactly what the negative consequences will be – I find myself perplexed. A screwed up capital structure and a moribund economy with manageable inflation? Massive cronyism? Loss of control and finally unexpected massive inflation?