Tuesday, August 10, 2010

FOMC Statement, August 8

Today's FOMC statement has some news in it.

1. There is a recognition of the somewhat more gloomy news on the real side.
2. The difference in policy comes here:
To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve's holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities. The Committee will continue to roll over the Federal Reserve's holdings of Treasury securities as they mature.
Thus, the Fed will for the time being keep the size of its balance sheet constant. They could have been more aggressive, and made moves to purchase more assets - MBS, Treasuries, or agency securities. They could have announced that they would sell off MBS and agency securities, or that they would reduce the average maturity of Treasuries on the Fed's balance sheet to something resembling what it was in the past. Relative to the other possibilities, what the Fed will actually do is a somewhat modest middle road.

The interpretation of this move is that the Fed wants to be active in responding to real events in the economy, but has some concerns about further intervention through private asset purchases. Is maintaining the size of the stock of long-maturity assets on the Fed balance sheet a good idea? There is risk, due to the mismatch in maturities on either side of the Fed's balance sheet, and I don't think anyone, including those on the FOMC, have any idea what the effects are of intervention in long-maturitity Treasuries. Now would be a great time for the Fed to sell long-maturity assets, while the prices are high, and I think this would have little or no effect on interest rates.


  1. Since when is FED concerned about p&l?

    And why are you concerned about maturity profile of FED balance sheet so much more than with maturity profile of private sector balance sheet?

  2. "I don't think anyone, including those on the FOMC, have any idea what the effects are of intervention in long-maturitity Treasuries"

    True, though there are a couple of papers (FRB NY and Boston) that attempt to quantify the effect of QE (or "credit easing" in Bernanke's parlance).

  3. I should have added that there is also a WP from the BoE on the same subject.

  4. In a separate statement, the Fed announced a new purchasing program:

    "The central bank said in a separate statement that it will announce a purchasing schedule today and that its buying will be concentrated “in the two- to 10-year sector” of the maturity spectrum, though it will also buy other maturities as well as Treasury Inflation Protected Securities."

  5. The process we are seeing now is:

    Trade deficit increasing --> Unemployment increasing --> Lower wages -->Not any recovery in consumption expected --> less tax collection--> High indebtness of government, companies and families --> lower expectations of all the economic agents ---> less investment (public and private) ---->less industrial production ----> Trade deficit increasing

    At the end---> Recesion and deflation trap

    The same process have been hapenning from more than 15 years ago, but to avoid the recession, the economy was based in a long succession of bubbles (mergers, dotcom, raw mats, real state...) and in the cheap credit (due to low interest rates), meantime the industrial outsourcing were growing exponencially, all in a unsustainable way.

    But now all the speculative business and the cheap credit is gone (as the authorities and economist should have expected) and we need a REAL economy, based on manufacturing REAL products, not merely smoke

    Now, with the crisis, the trade deficit with emerging countries (mainly China) is widening because with the lower earnings of the families, the people trend to buy the cheapest products, looking for price, not quality, and that is the advantage of the chinese goods compare to US products (a lot of them made by chinese companies, more and more, not outsourced by western companies)

    To print more money to increase the exports sounds good, but the debt holders are the countries more interested in maintaning the soaring trade deficit of US (mainly China and also Japan)
    And the liquidity and solvency of China is a good leverage to avoid the hardly needed "protectionist temptation"

    The next steps of the process is a reduction of the life standard and social protection for all the people in western countries (except the very rich, they will earn more, of course and also a huge strategic change in the economic power balance in favour of China