Yesterday's statement was quite unconventional: the body of the statement was five paragraphs compared to four in the October statement; the Fed shortened it's downside risks to growth paragraph (second paragraph); the Fed added a sentence to the inflation paragraph that indicates angst regarding price instability (in blue); a new paragraph detailed the Fed's promise to use "all available tools", and that the fed funds rate will be "low for some time"; and finally, the fifth paragraph - which last time highlighted how the FOMC believed that its actions "should help over time to improve credit conditions and promote a return to moderate economic growth" - lists the Board of Governors' promised policy measures. These measures include the following:
- "sustain a balance sheet at a high level "- quantitative easing.
- purchase MBS and agency debt in "large quantities" - change the composition of its balance sheet.
- possible purchase of long-term Treasuries - change the composition of its balance sheet
- TALF, or buying asset-backed securities (ABS) collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration (SBA) - change the composition of its balance sheet.
The Fed in concerned that the financial crisis - if left untreated - will seriously injure the real economy. In some sense, the Fed's measures are working: commercial paper - propped up by the Fed's $309 billion net-holdings (as of 12/16/08) - is still functioning, the money supply is still growing (including institutional money funds in November), and the Fed-regulated banking system is still lending.
Some of my readers have expressed their strong disapproval of the Fed's policy measures, and clearly the Fed's exit strategy will be crucial. I am skeptical of the Fed's ability prevent added inflationary pressures down the road, but given the extreme downside risks to growth, I believe that the Fed is doing the right thing here. The Fed is feeding off of a credible monetary system (and rightly so, according to the TIC flows) to stave off a deflationary spiral. Barring significant inflation down the road, that is the right choice.
But with Congress' pledge to increase the size of its stimulus package with each week that passes (see this post and this post), I am re-evaluating my stance on fiscal policy, but I need to be convinced. Feel free to send me any intelligent economic material on the subject of expansionary fiscal policy, either by emailing me or by linking directly from the comment section.
One thing is certain, though: textbooks teach us that when the central bank is faced with a liquidity trap (no more stimulus left in monetary policy, i.e., reducing rates), fiscal policy must complement monetary policy. But there is still some stimulus out there -many long-term rates that matter to consumers are still elevated relative to short-term rates: mortgages, auto loan, etc. If those rates fall - 30-year mortgage down 0.06% to 5.47% on December 12, 2008 - then some economic activity may emerge.