The US is in a bit of a rut, that is for sure. And the banking crisis, which has currently resulted in just 27 failed banks since January 2008, is ongoing, while the economy is taking a serious turn for the worse. Pretty soon, a systemic crisis will emerge, with mass bank failure and a wipe out of depository institution capital. Or not.
The Fed is trying desperately to avoid this situation through reserve creation and various targeted lending programs. I am still interested as to why Fed officials have used so much air time differentiating current Fed policy from the Bank of Japan's (BoJ) quantitative easing policy (QEP) during Japan's lost decade. Finally, we know. When spoken in reference to the Fed's current balance sheet efforts, we must use the term credit easing.
From Bernanke's speech this week:
The Federal Reserve's approach to supporting credit markets is conceptually distinct from quantitative easing (QE), the policy approach used by the Bank of Japan from 2001 to 2006. Our approach--which could be described as "credit easing"--resembles quantitative easing in one respect: It involves an expansion of the central bank's balance sheet. However, in a pure QE regime, the focus of policy is the quantity of bank reserves, which are liabilities of the central bank; the composition of loans and securities on the asset side of the central bank's balance sheet is incidental. Indeed, although the Bank of Japan's policy approach during the QE period was quite multifaceted, the overall stance of its policy was gauged primarily in terms of its target for bank reserves. In contrast, the Federal Reserve's credit easing approach focuses on the mix of loans and securities that it holds and on how this composition of assets affects credit conditions for households and businesses. This difference does not reflect any doctrinal disagreement with the Japanese approach, but rather the differences in financial and economic conditions between the two episodes. In particular, credit spreads are much wider and credit markets more dysfunctional in the United States today than was the case during the Japanese experiment with quantitative easing. To stimulate aggregate demand in the current environment, the Federal Reserve must focus its policies on reducing those spreads and improving the functioning of private credit markets more generally. Okay, so the Fed does not have an official target for bank reserves, but rather credit spreads. Therefore, it is engaging a credit easing policy (CEP), rather than a quantitative easing policy (QEP). But Fed officials have also claimed that a large difference between the Fed's and the BoJ's easing policies is the following: Japan’s quantitative easing program focused on the liability side, expanding cash in the system and excess reserves by a large amount. Janet Yellen also made this same claim. This is a difference that I just don't see in the data.
You have the BoJ's QEP...
...And then there's the Fed's CEP
But to me, the biggest difference is timing. The Bank of Japan announced its QEP over three years after the banking crisis had officially begun in November 1997. And the Fed officially announced its CEP - at least its intent to keep the balance sheet "elevated" - just over a year after the US banking crisis started August 2007.
And furthermore, the Fed has really jumped into its reserve creation with full force - 108% reserve growth in the month of its CEP announcement (December 2008). The Bank of Japan took their time, incrementally raising the reserve target over its several years of QEP. Japan's monetary base (reserves plus currency) grew by just 2/3 in the three years (66%) following the QEP announcement.
So whether or not the Fed is actively seeking a reserve target, which it's not, seems to me to be irrelevant. What I do find interesting is the fact that Yellen announced that the BoJ focused on currency reserve creation. That just doesn't show up in the data (see currency growth in the charts above).
To be sure, the area in which the Fed has had its greatest impact is in the commercial paper market. The Fed's $334.6 billion net-purchase of commercial paper has lowered spreads (Chart source: The Federal Reserve).
It is a relief to have a new term to describe the Fed's easing policy, credit easing. It has become quite clear the the Fed's primary objective is to lower spreads on debt in non-Treasury market's, and that CEP is - for now - working.
The Fed's measures, while drastic, are working. But I am still unclear as to what the Fed's exit strategy will be, and this is all that Bernanke has given us:"We are monitoring the maturity composition of our balance sheet closely and do not expect a significant problem in reducing our balance sheet to the extent necessary at the appropriate time."If the appropriate time is after evidence of inflation has emerged, well, then it will already be too late. For now, though, the Fed's biggest worry is this nasty recession that is underway; and its repercussions on the already-impaired credit markets.