The Federal Reserve Board has released the minutes of the Federal Open Market Committee (FOMC) meeting of Aug, 10, 2010, which show committee members wrangling over whether, and how much, to initiate programs to add stimulus to the economic recovery. While they ultimately decided to reinvest repayment of the asset-backed securities that the Fed had purchased during the financial crisis into longer-term Treasuries, concerns remained that such a move might send an “inappropriate” signal that the Fed was wiling to resume large-scale asset purchases. In other words, not all FOMC members agree with a strategy of rescuing markets by endlessly printing money. They are rightly concerned about the long-term effects of using the Fed’s balance sheet.
In any event, investors had better be careful buying risky assets in a belief that the Fed will do anything to keep asset prices elevated. It is one thing for the Fed to help markets along, buying time until the private sector can resume its rightful place as the main investor in the economy. The TARP program, in its original form, is exactly the right type of program. Put money into banks to get confidence back, and then get the money back quickly and let private investors take the risk. However, there comes a time when, with private investment still balking at entering markets, the government must admit that a fundamental transformation of the economy is underway and look for ways to help accommodate change, rather than continue to pour money into dying markets – a strategy that could have very negative implications down the road. No one wants to see equity, housing and other markets drop, but corresponding declines in commodities would ultimately be very good for consumers. The stock market will eventually adjust upward and, meanwhile, consumers may be able to get on better footing with lower food and energy costs. Perhaps the Fed, and thus the U.S., would be better off encouraging deleveraging by continuing the withdrawal of liquidity programs, allowing enough for credit markets to continue operating, but so much that it encourages speculators to drive up prices of commodities and other risky assets. Thus far, it seems that the liquidity programs have not produced more jobs, just more speculation. For more on this subject, please see Prof. Greg Mankiw’s Blog: A Challenge to Extreme Keynesians.
Here is a key passage from the minutes:
[T]he Committee discussed the implications for financial conditions and the economic outlook of continuing its policy of not reinvesting principal repayments received on MBS or maturing agency debt. The decline in mortgage rates since spring was generating increased mortgage refinancing activity that would accelerate repayments of principal on MBS held in the SOMA. Private investors would have to hold more longer-term securities as the Federal Reserve’s holdings ran off, making longer-term interest rates somewhat higher than they would be otherwise. Most members thought that the resulting tightening of financial conditions would be inappropriate, given the economic outlook. However, members noted that the magnitude of the tightening was uncertain, and a few thought that the economic effects of reinvesting principal from agency debt and MBS likely would be quite small. Most members judged, in light of current conditions in the MBS market and the Committee’s desire to normalize the composition of the Federal Reserve’s portfolio, that it would be better to reinvest in longer-term Treasury securities than in MBS. While reinvesting in Treasury securities was seen as preferable given current market conditions, reinvesting in MBS might become desirable if conditions were to change. A few members worried that reinvesting principal from agency debt and MBS in Treasury securities could send an inappropriate signal to investors about the Committee’s readiness to resume large-scale asset purchases. Another member argued that reinvesting repayments of principal from agency debt and MBS, thereby postponing a reduction in the size of the Federal Reserve’s balance sheet, was likely to complicate the eventual exit from the period of exceptionally accommodative monetary policy and could have adverse macroeconomic consequences in future years.
To read the FOMC minutes in full, please click the following link: Minutes of the Federal Open Market Committee: Aug. 10, 2010.
Gregg D. Killoren
victoria1014
