Thursday, March 19, 2009

More unconventional monetary policy responses

The Fed announces more unconventional responses, by deciding to pump an extra $1 trillion into the financial system by purchasing long term Treasury bonds and mortgage securities. This decision makes the Fed a buyer of long-term government bonds rather than the short-term debt that it typically buys and sells to help control the money supply (first time in over 50 years it is buying long term securities), in the hope that it will push down long term interest rates on all types of loans, especially home mortgages.

The plan consists of two parts - an additional purchase of $750 billion worth of government-guaranteed mortgage-backed securities on top of the $500 billion that the Fed is already in the process of buying, and purchase of $300 billion worth of longer-term Treasury securities over the next six months. The first is part of an effort by the Fed to act as a lender of last resort in a frozen credit market, while the second is part of attempts to bring down long term interest rates.

These expansions would expand the Fed's balance sheet to well past $3 trillion, from $900 bn in Spetember 2008. Including this, the government has made commitments of about $9.9 trillion and spent $2.2 trillion. This includes $5.4 trillion in direct investments in financial institutions, purchases of high grade corporate debt and mortgage backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae; and $2.3 trillion in overnight lending to banks, including extending terms to as many as 90 days and allowing borrowing by other financial institutions; $2.1 trillion in insuring debt issued by financial institutions and guaranteeing poorly performing assets owned by banks and Fannie Mae and Freddie Mac.

However, the magnitude of the expansion, which amounts to virtually printing money and increasing the money supply, raises concerns about the long term prospects, especially inflationary expectations and the value of dollar. Reactions from economists here.

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