Monetary policy in disarray
Monetary policy has become difficult to characterize or follow since 2007. A debate as to whether interest rate targets or monetary aggregate targets are better indicators of policy and prospective outcomes has given way to a new credit policy built on inflating the Federal Reserve (Fed) balance sheet to provide private sector credit. This policy grew out of the Great Depression and has led the Fed to ignore monetary growth and render a federal funds rate target impotent by pushing it to zero. To implement the more than doubling of the Fed’s assets, the Fed took up commercial banking policies. Three examples are: selling Treasury assets to fund private assets, paying subsidies to banks for holding reserves and attracting a new class of Treasury debt sterilized in Fed deposits. These actions insulated monetary aggregates and the effective monetary base from the explosion in the Fed’s balance sheet. The new credit policy severed the tight link that had existed for over 70 years between Fed credit and its effective monetary base. Fortunately, it also insulated the economy from a more than doubling of the general price level. But these actions have turned the balance sheet of the Fed into a collection of illiquid and risky private assets. A similar portfolio of government securities that has the longest duration in history and therefore the greatest interest rate risk limits the Fed’s ability to reduce its assets or the excess reserve position of banks, exceeding $1.5 trillion and costing the taxpayer over $3.3 billion, from 2009 to mid-2011. The subsidy and excess reserve levels of the first half of 2011 will cost $2.3 billion per year going forward. Finally, the paper rebuts claims by Fed officials that the Fed has successfully followed the framework of monetary policy developed by Milton Friedman. The paper concludes with recommendations for Congressional restrictions on the Fed and Treasury to ensure that the Fed focus on responsible monetary policy and not its failed credit policy.
|Date of creation:||27 Aug 2011|
|Date of revision:|
|Contact details of provider:|| Postal: Ludwigstraße 33, D-80539 Munich, Germany|
Web page: https://mpra.ub.uni-muenchen.de
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Michel Aglietta & Laurence Scialom, 2008. "Permanence and innovation in central banking policy for financial stability," EconomiX Working Papers 2008-21, University of Paris West - Nanterre la Défense, EconomiX.
- Mark A. Wynne, 2003. "The Legacy of Milton and Rose Friedman's Free to Choose: Economic Liberalism at the Turn of the 21st Century--Introduction," Proceedings, Federal Reserve Bank of Dallas, issue Oct, pages 3-17.
- Tatom, John, 2006. "Money Growth Has Slowed Sharply—Should Anybody Care?," MPRA Paper 17780, University Library of Munich, Germany.
- Joseph E. Gagnon & Matthew Raskin & Julie Remache & Brian P. Sack, 2011.
"Large-scale asset purchases by the Federal Reserve: did they work?,"
Economic Policy Review,
Federal Reserve Bank of New York, issue May, pages 41-59.
- Joseph E. Gagnon & Matthew Raskin & Julie Remache & Brian P. Sack, 2010. "Large-scale asset purchases by the Federal Reserve: did they work?," Staff Reports 441, Federal Reserve Bank of New York.
- Peter Stella & Ulrich H Klueh, 2008. "Central Bank Financial Strength and Policy Performance; An Econometric Evaluation," IMF Working Papers 08/176, International Monetary Fund.
- Epstein, Gerald & Ferguson, Thomas, 1984. "Monetary Policy, Loan Liquidation, and Industrial Conflict: The Federal Reserve and the Open Market Operations of 1932," The Journal of Economic History, Cambridge University Press, vol. 44(04), pages 957-983, December.
- Massimo Guidolin & Christopher J. Neely, 2010. "The effects of large-scale asset purchases on TIPS inflation expectations," Economic Synopses, Federal Reserve Bank of St. Louis.
When requesting a correction, please mention this item's handle: RePEc:pra:mprapa:34607. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Joachim Winter)
If references are entirely missing, you can add them using this form.