No, it doesn't. That's because the Fed has another tool in its arsenal: 'quantitative easing.'
Quantitative easing involves increasing the reserves in the banking system after the Fed loses the ability to lower the cost of money from an interest rate standpoint.
The size of the resources available for quantitative easing policy varies on how much money the Fed believes it has to deploy, so says economist David H. Wang. One school argues that the amount of money available is up to a set percentage of U.S. GDP, for example 15% or 20%, he said. However, another school argues that the amount of money available is much larger than that, Wang added.
The Fed's balance sheet has surged to $2.2 trillion this month from about $924 million in September, when the first wave of the financial crisis began to freeze credit markets and decimate stock markets around the world, he said. Further, the Fed's balance sheet is likely to increase as other interventions become necessary to stabilize the financial system. For example, the Fed is on the hook for up to another $240-265 billion as a result of Monday's rescue of Citigroup (NYSE: C).
Is the Fed in danger of hitting a balance sheet ceiling? No, says Wang. "At $3 trillion the Fed's balance sheet will total about 20% of GDP. That's high, but not, unprecedented, in global terms," Wang said. "The Bank of Japan's quantitative easing policy early this decade led to a balance sheet that was 30% of GDP."
Rampaging inflation ahead? No
An obvious question concerns inflation. With the Fed and U.S. Treasury both adding money to the financial system, does the U.S. run the risk of a large rise in inflation? "Intuitively, one would say yes, but this a case where intuition is wrong," Wang said. "People have to remember that while the Fed and Treasury are adding trillions of dollars to the system, trillions of dollars have been eliminated from the system in the form of bad bonds, housing price declines, and of course, stock market declines. The larger risk for the year ahead and probably longer remains deflation not inflation."
Monetary Policy / Economic Analysis: The inflation hawks are certain to decry the Fed's increasing balance sheet, but don't listen to their rhetoric: track inflation in the months and quarters ahead. Monitor what happens to home prices, consumer prices, and commodities. The view from here argues that inadequate economic growth will create an environment where prices are likely to decrease, not increase, until the U.S. recovery starts. As the economic recovery begins, the inflation risk rises, but that risk is distant, as the nation is a long way from recovery.
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Reader Comments (Page 1 of 1)
11-25-2008 @ 2:55AM
BHarrison said...
I've never been one for the "conspiracy nut cases"; but I think that the extent of our political and economic situation fairly well demonstrates that the radical elitist/ultr-wealthy special interests groups such as the Bilderberg Group, and the Tri-Lateral Commission have effectively been controlling our political system via their behind the scenes control of BOTH the Republican AND the Democratic parties, and their control of the Fed and the FIs - Financial institutions. Even NOW, the vast majority of Americans do not relaize that the Fed, the Federal Reserve, is NOT a government agency; that it is a PRIVATE CORPORATION of the most wealthy "banks" in the world (foreigners) who control our financial institutions. They put an American "frontman" such as Greenspan in charge as a figure head; but the control of the Fed is by 'WEALTHY FOREIGN BANKS". This information is a matter of public record;, and often referred to inpublic comments about the Fed; but most Americans are simply oblivious to it because they are too apathetic to even try to understand what is going on. Americans feel impotent about being able to do anything about these situations, so they do nothing; and the situations progressively worsen. If everyone would make repeated attempts to raise hell with their Congressmen some improvements might be possible. Do nothing; and nothing will improve.