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Jun 12

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Here we go again…more Fed insanity

At this point, some may be wondering why a picture of the Federal Reserve Bank is not posted next to the definition of insanity (i.e., doing the same thing over and over and expecting a different result).  After the most recent barrage of economic bad news last week (e.g., increased unemployment rate, lowered 1st quater GDP growth, etc.),  some Federal Reserve members are indicating that either another round of “Quantitative Easing” (aka QE) and/or extending “Operation Twist” may be in the works.  If the first few rounds did not work, what makes the Fed think additional rounds will?

Recall that QE is an unconventional monetary policy used by the Federal Reserve to stimulate the economy.  Under QE, the Fed buys government bonds with new money that the central bank creates (i.e., prints).  This increases the money supply and the reserves within the banking system.  This purchasing raises the prices of the Treasury instruments bought, which in turn lowers the yield.  In November 2008, the Fed initially announced a $600 billion QE program, but then increased that to $1.8 trillion four months later.  In November 2010, the Fed announced a second round of bond purchases (aka QE2), totaling $600 billion in long-term Treasuries over the next eight months, plus $250 billion to $300 billion reinvested in Treasuries with the proceeds of its earlier investments.   These two rounds of QE have resulted in unprecedented growth in the money supply (among other things) that will likely result in unprecedented inflation.

In September 2011, the Fed began Operation Twist, a program used to lower borrowing costs via the Fed buying long-term Treasurys and selling short-term debt.  Essentially this reduces longer-term interest rates without expanding the Fed’s balance sheet (unlike QE that expands its balance sheet).   Under Operation Twist, the Fed sold $400 billion of Treasuries with maturities of three years or less and used the proceeds to buy $400 billion of Treasuries with maturities of six years or more.  The program is set to expire this month in June.  Some Fed members are suggesting that this program be extended to ignite the economy.

Although some believe that these unconventional monetary policies helped ignite the economy, the “help” is mild to modest at best as the overall economy continues to remain ill.  These policies were taken because the conventional monetary polices had already been exhausted and failed.  Continuing failed policies and expecting a different result may be considered insane.  But if we are going to continue down the insanity road, it may be better to continue down the failed conventional policy road than the unconventional policy road.  On this road, at least we are aware of the consequences and how to deal with them.  The unconventional road is unchartered territory.  A recent blog discusses the unchartered territory with the Fed’s own data.  That blog can be found here.

About the author

Nicole Liska

I am a Principal at Fulcrum Inquiry, an accounting and economic consulting firm that performs damage analysis for commercial litigation, forensic accountings, financial investigations, and business valuations. I hold an ABD and MA in economics from the University of California, San Diego. I perform damages analyses and serve as a damages expert witness. My resume is on Fulcrum's website.

Permanent link to this article: http://betweenthenumbers.net/2012/06/here-we-go-again-more-fed-insanity/

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