The Fed’s message: We’re not the Bank of Japan
The Fed is increasingly discussing its monetary policy goals, and it’s about time. But I have noticed that the Fed is being very careful not to use the term quantitative easing (QE) when describing its current policy measures. If not read carefully, one might assume that the Fed is not engaging in a policy of quantitative easing, when in fact, it is.
What the Fed is trying to say is this: we are pursuing a QE policy, but differently than did the Bank of Japan earlier in the decade because; we are not growing the liabilities side of our balance sheet. This seems little silly, as the Fed may very well start printing currency if prices continue to decline. Note: See this post for a discussion of quantitative easing, the Fed’s creation of reserve balances, and the “printing of money.”
The Fed finally stated its intentions
1. The Fed had its big coming-out monetary policy party when it announced a near-zero interest rate policy on December 16. Before that, one could only speculate as to what the Fed’s intentions really were. In the Fed’s announcement of its intentions to use any means necessary to promote economic growth and price stability, the word quantitative was not used, except to refer to the purchase of “large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets”. No mention of quantitative easing, when in fact, that is exactly what the Fed is doing.
2. In a press conference directly following the Fed’s announcement, the Wall Street Journal reported:
But the senior Fed official said the central bank’s approach is distinct from quantitative easing and different from what the Japanese did. The Fed’s balance sheet has two sides, the official explained: assets with securities the Fed holds (including loans, credit facilities, mortgage-backed securities) and liabilities (cash and bank reserves). Japan’s quantitative easing program focused on the liability side, expanding cash in the system and excess reserves by a large amount. The Fed’s focus, however, is on the asset side through mortgage-backed securities, agency debt, the commercial paper program, the loan auctions and swaps with foreign central banks. That’s designed to improve credit-market functioning, the official said. By expanding the balance sheet by making loans, the official explained, the focus is not on excess reserves but on the asset side. That securities-lending approach directly affects credit spreads, which is the problem today — unlike Japan earlier, where the problem was the level of interest rates in general, the official said.
On the surface, it may seem appropriate to equate the Fed’s use of its balance sheet to stimulate the economy with the quantitative easing policy pursued earlier by the Bank of Japan. But as I noted at the outset, the differences outweigh the similarities in my opinion. The main similarity is that the Fed, like the Bank of Japan, has increased the quantity of excess reserves in the banking system well above the minimum level required to push overnight interbank lending rates to the vicinity of zero. The creation of such a large volume of excess reserves, in the Fed’s case, results from the enormous expansion in the Fed’s discount window lending, foreign exchange swaps, and asset purchases. In the Bank of Japan’s case, the expansion in excess reserves resulted from the deliberate adoption of an explicit numerical target for them. The theory underlying the Bank of Japan’s intervention was that banks might be encouraged to lend by replacing their holdings of short-term government securities with excess cash.
The Fed is pitching the same line: our policy is different from the Bank of Japan’s (BoJ) policy measures earlier in the decade. Janet Yellen went as far as to imply that the Fed is not engaging in a QE policy. But Bernanke himself defines QE as “providing bank reserves at levels much greater than needed to maintain a policy rate of zero” (page 5 of Bernanke, Reinhart, and Sack), whichis exactly what the Fed is doing. The Fed IS engaging in QE policy, but somewhat differently than did the Bank of Japan.
Like the BoJ, the Fed is growing its balance sheet through reserve creation. The Fed has been quite explicit about this, citing the funding of the MBS purchase program and GSE debt through reserve creation.
This should be a familiar chart by now. It illustrates the Fed’s various lending policies listed in its balance sheet. The Fed has increased the credit extended to the commercial banking system by $1.35 trillion in just one year, mostly through the creation of reserves.
The Bank of Japan targeted commercial bank reserves – through the printing of currency and creation of reserves – to a level of 30-35 trillion yen. The Fed has made no such target.
Unlike the BoJ, the Fed’s liabilities are falling.
The chart illustrates the liabilities side of the Fed balance sheet. As you can see, with the unwinding of the TSP account (see this post ), the liabilities of the Fed are falling rather than rising. And furthermore, the Fed is not growing its currency stock in bulk. The BoJ’s liabilities would have been rising precipitously, as it flooded the banking system with yen (printing currency).
So the Fed isn’t printing hard currency. I find this to be a rather mute point, as the Fed would probably like to see a little inflation right about now. James Hamilton argues that the Fed should consider increasing bank cash holdings to create some inflation. Inflation would lower the real debt burden of households and firms, ensuring that debts at least could be paid off. In the Wall Street Journal, Kenneth Rogoff argues: that “a little inflation would be a good thing”.
The Fed said that it will “employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability”; that certainly doesn’t preclude the printing of currency. I wouldn’t be surprised if the Fed started to print currency soon (it has already increased the currency stock by $44.5 billion since October 8) to promote a little inflation.
Originally published at the News N Economics blog and reproduced here with the author’s permission.