The pictorial Quantitative Easing | FT Alphaville

The pictorial Quantitative Easing

Didn’t get around to our prescribed quantitative easing reading?

Never fear, FT Alphaville, via Bank of America’s excellent credit team, gives you the pictorial Fed QE:

BoA - QE

In words: The Fed’s liquidity programmes, such as the TAF, have combined to inject about $1,100bn into the financial system (Figure 10) — and simultaneously jacked up the Fed’s assets. Normally the Fed offsets an increase in its assets by selling new treasuries, which decreases the amount of currency in circulation and conversely increases its liabilities. This is called sterilisation and is one way the Fed can increase assets without expanding the money supply.

Only, as Figures 11 and 13 show, the Fed’s primary method of draining the excess liquidity (The SFP programme) has only gotten rid of about $500bn of that $800bn increase. The Fed is not fully sterilising its massive increase in assets — in effect it is increasing the money supply.

This is not necessarily a bad thing. For a start, inflation helps you pay off debts — which are fixed, and of which there are a lot in the US — by essentially devaluing your debt (and conversely, in a perverse sort of way, making the savings of those who had the foresight tendency to err on the side of prudence, worth less).

The inflationary effect is, however, mitigated by one thing — the breakdown of the money multiplier (Figure 12) as bank lending has seized up. Thus, money supply has increased, in this case measured by M1, but it’s increased less than the rise in the base money supply would suggest.

A final word on the matter, from BoA’s Jeffrey Rosenberg, regarding yesterday’s announcement that the Fed would start buying mortgage-backed stuff (MBS) from the GSEs Fannie and Freddie (emphasis our own):

Today’s Fed announcement on GSE purchases launches explicit QE that kills two birds with one stone. QE offsets the current deflationary impact of financial system distress and directing these purchases towards GSE debt and MBS may help reduce mortgage rates, a key goal to stabilizing the housing market. While QE may offset current deflationary risks, longer term these measures must be temporary to avoid creating their own problems of inflation and dollar devaluation, a risk highlighted by today’s USD decline and increase in gold…

Related links:
If all else fails, devalue the dollar – FT Alphaville
M3, where art thou? – FT Alphaville