Thursday, January 22, 2009

Unconventional monetary policy responses

As the sub-prime meltdown has progressed and as the interest rates have been driven down to the zero-bound and the credit squeeze has shown no signs of loosening, the Federal Reserve and the Treasury in the US has come up with a series of extraordinary and unconventional monetary policy measures. These responses effectively mean that the Government has become the lender, investor and insurer of last resort in the financial markets, in a last gasp effort to restore normalcy of credit flow in these markets. The government has so far guaranteed almost $ 8 trillion in investment, loans and deposits.

The NYT captures these responses in the excellent graphics shown below.





These responses are collectively called "quantitative easing", "which means having the Fed pump staggering amounts of money into the economy by buying up a wide range of debt instruments", all in an attempt to unfreeze the credit markets. Here is a brief of the $8 trillion plus guaranteed (but not fully spent) by the Government.

a) Insurer - Government has committed $3.2 trillion as guarantees to investors and depositers against default. These include the FDIC's insurance of senior-subordinated debt issued by banks till June 2009, and similar guarantees to money market funds, non-interest bearing deposit accounts, besides that provided to the distressed assets of Bear Stearns, Morgan Stanley, Freddie Mac/Fannie Mae, Citigroup and Bank of America (BoA).

b) Investor - Government has committed $3 trillion in cash in return for stakes in financial institutions. This includes, the Fed's role as buyer of last resort in the Commercial Paper (CP) markets, direct investments in financial institutions through the TARP, purchases of debt and mortgage bascked securities (MBSS) from the likes of Fannie Mae and Freddie Mac, and the direct stakes taken in AIG, Citigroup and BoA.

c) Lender - Government has committed $1.7 trillion in low interest loans to large financial institutions. This includes, the low interest loans using an expanded base of collateral, including asset backed securities, through the Term Auction Facility (TAF); and lending to investors holding securities backed by consumer and small business loans through the Term Assets Backed Securities Loan Facility (TALF).

d) Forex market - $755 bn as guarantee for currency swaps with Central Banks of other countries.

Update 1
Mostly Economics summarizes the Fed's credit easing responses here. A St. Louis Fed primer is available here.

Update 2
Quantitative easing basically means that the Fed is selling Treasury bills or their equivalent (interest-paying excess bank reserves are essentially the same thing), while buying other assets - mortgage-backed securities; securities backed by credit-card debt; longer-term government debt etc - expanding its balance sheet enormously in the process.

Update 3
Claudio Borio and Piti Disyatat have this nice summary of unconventional monetayr policy responses.

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