There's been some good conversation in the comments. I thought I'd pull out a few of my favorite bits.
The Fed's Balance Sheet Constraint
The interesting point that no one has commented on is the existence of a Fed balance sheet constraint on limits to the outstanding TAF.
The Fed is limited by the size of the liability side. It doesn't 'force feed' currency note into the system beyond the demand of the banks and the public for currency. And it has no room to expand bank reserve balances in aggregate of it wants to maintain control over the level of the funds rate. That's why it's 'sterilizing' now.
So the upper limit to TAF is essentially the size of the Fed balance sheet now, allowing for natural growth in currency demands of the banks and the public.
Beyond that, the Fed couldn't 'sterilize' by selling other assets. It would have to start issuing its own liabilities, such as the sterilization bonds issued by the PBOC used to offset their foreign exchange purchases.
Looking at the March 6 Factors Affecting Reserve Balances, in addition to the already announced TAF and repo programs, the Fed could initiate somewhere between $500 and $600B more in "sterilized interventions" (as Paul Krugman first pointed out these are) before it would have to issue bonds rather than selling existing assets.
There's more discussion of this point over at Brad Setser's (in the comments section).
Update: The Fed announced this morning that it will use up $200B more of that capacity via a "Term Securities Lending Facility". After the FAF expansion, repo program, and TSLF, the Fed will have between $300B and $400B in remaining sterilization capacity, unless it issues bonds directly. Paul Krugman, John Jansen, jck at Alea, Yves Smith, Michael Shedlock, Free Exchange, Justin Fox, Zero Beta (and see this!) comment.
Why the special repo program?
Why did the Fed announced the new repo program rather than just more dramatically expand TAF?
The new repo line... is nothing more than the TAF for the brokers who dont have access to the TAF. Essentially, a Merrill wants to have the same access to liquidity as JPMorgan but doesn't have it in the current framework of TAF which is only available to depositories. The new repo line just makes the same facility available to Merrill.
So the repo program can be looked at as a partial implementation of what Thomas Palley suggests. (In a pinch, apparently the Fed can lend directly to whomever it deems necessary, but that power has never been used. See David Wessel, "Analysts: Rate Cuts May Not Be Enough", ht Mark Thoma.)
Update: Livingston Guy wrote on Sunday, and was referring to the expanded repo program announced Friday, not the TSLF program announced Tuesday. However, both the expanded repo program and TSLF are available to primary dealers, whereas TAF is accessible only to depository institutions.
The /Price Spiral
[Regarding] a widely held misconception; namely that "inflation is the debtors friend". That IS kind of the way it worked during the Carter inflation as unions, now largely powerless due globalization, were largely able negotiate wage hikes rapidly enough to stay more or less even with inflation, creating the famous wage/price spiral which made debt an ever shrinking entity to the detriment of lenders. Nowadays we have just the /price part of that spiral, wages have been flat to negative in real terms for years. Without a means of increasing his income along with the inflating currency, the debtors debts in fact, instead of looking smaller, look ever larger as his required spending for necessities crowds out available funds for debt service, hastening insolvency.
Compare to a recent speech by Janet Yellen, President of the San Francisco Fed (via WSJ Real Time Economics):
Even so, I expect both total and core inflation to moderate over the next few years... This... assumes that inflation expectations will remain well-anchored, as they have been, and also that workers will not through their bargaining offset the real losses resulting from higher food and energy prices.
Things look different if you're a central banker.
- 11-Mar-2008, 10:45 a.m. EDT: Added update re "Term Securities Lending Facility". Attributed observation that these are sterilized interventions to Paul Krugman directly, rather than only implicitly via a link.
- 11-Mar-2008, 10:55 a.m. EDT: Cleaned up awkward wording introduced by reattribution in previous update.
- 11-Mar-2008, 11:05 a.m. EDT: Removed a redundant "in the comments". Sheesh.
- 11-Mar-2008, 1:05 p.m. EDT: Added Yves Smith to list of TSLF commenters.
- 11-Mar-2008, 2:55 p.m. EDT: Added Michael Shedlock to list of TSLF commenters.
- 11-Mar-2008, 3:55 p.m. EDT: Added update explaining that LG's comments were wrt repos, not TSLF. Added Free Exchange, Justin Fox, and Zero Beta to list of TSLF commenters.
|Steve Randy Waldman — Tuesday March 11, 2008 at 1:06am||permalink|