Thursday, January 29, 2009

Out of Bullets, Throwing Rocks: Fed Keeps Rate Near Zero, Is Ready to Buy Treasuries

They aren't really out of bullets.
Last February (has it already been a year?) We had a couple posts on the extraordinary measures the Fed could employ, from "Doom and Gloom: What Can the Federal Reserve Do?":
...More relevant to the American markets are a couple Fed papers, the first of which is astounding for its frankness:

Monetary Policy When the Nominal Short-Term Interest Rate is Zero.
...This paper also examines the alternative policy tools that are available to the Federal Reserve in theory, and notes the practical limitations imposed by the Federal Reserve Act. The tools the Federal Reserve has at its disposal include open market purchases of Treasury bonds and private-sector credit instruments (at least those that may be purchased by the Federal Reserve); unsterilized and sterilized intervention in foreign exchange; lending through the discount window; and, in some circumstances, may include the use of options.

...8.1 Money Rains
Money rains are a clean way to study theoretically the effects of increases in the supply of money. In practice, it seems a bit difficult to envision how the Federal Reserve could literally implement a money rain, that is give money away either through directly disbursing currency to the public or by disbursing it through the banking system....

And from my favorite post of the last year "Doom and Gloom: What Can the Federal Reserve Do? Part II":
...The paper's conclusions are worth an extended exerpt.

9 Conclusion
...When the nominal Treasury bill rate is at zero, the Federal Reserve could attempt to provide a stimulus to aggregate demand through effects in addition to those from increases in the monetary base. The Federal Reserve could purchase assets other than Treasury bills, such as U.S. Treasury bonds or foreign government debt. Even if these assets are perfect substitutes for U.S. Treasury bills, purchases of them could have a stronger stimulative impact than purchases of Treasury bills because of signalling effects."...
...To which we can only say Amen.
Another paper, this one from the Dallas Fed, addresses the same issues with a distinctly different tone, e.g.

CH-47 Chinook Helicopter

Image from Monetary Policy in a Zero-Interest-Rate Economy.

...Bold, but impractical–eliminating the bound altogether
The most daring suggestion for escaping the zero-interest-rate trap is one that eliminates the zero lower bound altogether. How can this be done? As noted in the first part of the presentation, the zero bound on interest rates exists because money pays a sure nominal interest rate of zero. No one would be willing to hold any asset that pays a negative nominal rate, as long as zero-interest money is available as a store of value. The strategy for eliminating the zero bound, therefore, is to make money pay a negative nominal interest rate, by imposing some type of ‘carry tax’ on currency and deposits....

Also from that post:
...Finally. from a speech to the National Economists Club by Ben S. Bernanke, Nov. 21, 2002

Deflation: Making Sure "It" Doesn't Happen Here
Some of the footnotes to the speech:

8. Keynes, however, once semi-seriously proposed, as an anti-deflationary measure, that the government fill bottles with currency and bury them in mine shafts to be dug up by the public...
See! The Fed has lots of ammo left!
Here's the headline story from Bloomberg:
The Federal Reserve left the benchmark interest rate as low as zero, said it’s prepared to purchase Treasury securities to resuscitate lending and warned inflation may recede too quickly.

The Fed is ready to buy “longer-term Treasury securities if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets,” the Federal Open Market Committee said in a statement today in Washington. Any purchases before the FOMC’s next meeting in March would still need a vote to authorize the action.

Chairman Ben S. Bernanke, by making emergency credit programs rather than rates the focus of policy, is quelling some of the panic in markets while failing to revive growth. Falling home prices, rising unemployment and more than $1 trillion in losses and writedowns at global financial institutions are deepening the longest recession since the 1980s....MORE