Saturday, January 17, 2009

Credit Easing Policy - Now we know what to call the Fed's easing measures

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.

Rebecca Wilder


  1. Chairman Ben S. Bernanke, We Are Opting Out of Credit.

    All of Our Economic Problems Find They Root in the Existence of Credit.

    Out of the $5,000,000,000,000 given out to the banks, that is $1,000 for every inhabitant of this planet, what is it exactly that WE, The People, got?

    A Credit Free, Free Market Economy Is Possible.

    Both Dynamic on the Short Run & Stable on the Long Run.

    I Propose, Hence, to Lead for You an Exit Out of Credit:

    Let me outline for you my proposed strategy:

    Preserve Your Belongings.

    The Property Title: Opt Out of Credit.

    The Credit Free Money: The Dinar-Shekel AKA The DaSh, Symbol: - .

    Asset Transfer: The Right Grant Operation.

    A Specific Application of Employment Interest and Money.
    [A Tract Intended For my Fellows Economists].

    If Risk Free Interest Rates Are at 0.00% Doesn't That Mean That Credit is Worthless?

    Since credit based currencies are managed by setting interest rates, on which all control has been lost, are they managed anymore?

    We Need, Hence, Cancel All Interest Bearing Debt and Abolish Interest Bearing Credit.

    In This Age of Turbulence The People Wants an Exit Out of Credit: An Adventure in a New World Economic Order.

    The other option would be to wait till most of the productive assets of the economy get physically destroyed either by war or by rust.

    It will be either awfully deadly or dramatically long.

    A price none of us can afford to pay.

    “The current crisis can be overcome only by developing a sense of common purpose. The alternative to a new international order is chaos.”

    - Henry A. Kissinger

    Let me provide you with a link to my press release for my open letter to you:

    Chairman Ben S. Bernanke, Quantitative [Ooops! I Meant Credit] Easing Can't Work!

    I am, Mr Chairman, Yours Sincerely,

    Shalom P. Hamou AKA 'MC Shalom'
    Chief Economist - Master Conductor
    1 7 7 6 - Annuit Cœptis
    Tel: +972 54 441-7640

  2. Bernanke has it wrong.

    Bernanke believes the economic collapse stems from aggregate demand (buying stuff) problems owing to a lack of credit, which is another word for debt, i.e., rented cash.

    As Bernanke said, "To stimulate aggregate demand ... the Federal Reserve must focus ... on reducing ... spreads and improving ... private credit markets."

    Yet, Bernanke should learn J.B. Say's Law -- Supply makes it's own demand.

    When Americans' buying power (unit buying of a dollar relative to goods) fell, they lacked the cash to pay for living expenses (gasoline, food) and to pay for debt service (mortgages, home equity loans, credit cards).

    Thus, businessmen had expanded production and sales channels based upon false beliefs about Americans' state of ability to pay.

    Now, Americans have lost their jobs as businesses rush to correct their mistakes made from their false beliefs.

    Americans need jobs, jobs that produce things of worth made from a competitive advantage stance.

    Fast food and retail jobs cannot support debt loads.

    Americans need jobs that produce things in great demand both from foreigners and from other Americans.

    Until that happens, buying power cannot return to Americans, hence, Americans shall lack the means to pay both debt service, living expenses and for luxury goods.

    The shift must go from consumer credit to commercial credit, from housing production to nanotechnology production (or things alike).

    When buying power returns to Americans beyond paying for food, rent and fuel, Americans shall become able to pay for credit card balances and the like.

  3. Is the inherent difference between Japanese and American psychology at play here? The Japanese have a hard time admitting they are wrong, hence the 3 year lag to action. We, however, tend to act pretty fast but not always wisely. QE or CE, now that is the difference.
    Hope you've been OK! aj

  4. Rebecca - you say it took Japan 3 years for QEP and the US 1 year for its CEP. The world ex-japan seemed to be doing fine from 1997 to 2000 so maybe the Japanese thought time was on their side. Now that the whole world has been seriously shafted since August 2007, what is the relevance of any comparison? Maybe the US is still doing too little too late.

    Like you, I am worried about the inflationary consequences, but there's an interesting take on this here:

    I'd be interested to know if you feel ndk's views have any validity and change the argument a bit - thanks!

  5. OK, so QE doesn't work because it pumps up banks and they aren't lending. So CE works because the Fed is lending heavily in the CP market (90+% of it?). Since TED spreads are narrowing, does this mean credit is easing? Are banks lending more? Are borrowers borrowing more? I have a hard time grasping this. Thanks.

  6. The evidence of inflation, is represented by "actual" prices in the marketplace.

    The "administered" prices would not be the "asked" prices were they not “validated” by (MVt).

    Gasoline prices have started to rise.

  7. Beware the Ides of March (when Julius Caesar was assassinated in 44 BC).

    I.e., beware of the indian-giver, or the FED's seasonal mal-adjustments.


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