Fantasy Fed options | FT Alphaville

Fantasy Fed options

While the world seems divided on whether Friday’s Jackson Hole meeting will result in the announcement of a fresh round of quantitative easing or not — we thought we’d run with the premise that QE in its conventional form is now redundant or impossible.

(For why we think this, see here and here.)

So what, if any, are the possible alternatives?

Here are some we’ve seen thrown about recently:

From Neal Soss at Credit Suisse:

1) Providing liquidity directly to key credit markets — this basically means renewed TALF style facilities, with the aim of getting high-powered money distributed into the real economy via businesses.

2) Making term bank loans with strings attached (a la BoJ) — a plan which essentially restricts Fed funding to institutions that can come up with productive use of the money.

3) Lending directly to small businesses.

4) Allowing Fed to buy longer-term municipal securities.

5) Issuing money that depreciates in value over time to spur consumption — a.k.a negative interest rates. Though this runs the risk of inducing capital destruction too.

From Scott Sumner:

6) Fed should start targeting nominal GDP — i.e. forget about inflation targeting altogether and start targeting nominal GDP via nominal incomes and something called NGDP futures. In Sumner’s own words:

It would be something like the classical gold standard, but with the dollar defined in terms of a specific NGDP futures contract, instead of a given weight of gold. The public, not policymakers in Washington, would determine the level of the money supply and interest rates most consistent with a stable economy.

Banks would fail, but the money supply would adjust so that expected future nominal spending continued to remain on target. Creative destruction could do what it’s supposed to do, with jobs lost in declining industries being offset by jobs gained in creative new enterprises.

More on how that works here.

Now for some far out FT Alphaville ideas:

7) Fed intervenes directly via the derivative market by actually writing a literal Bernanke put — Similar to the above, though this time the Fed would be targeting equity market levels rather than GDP.

8) Fed adjusts conventional QE — instead of purchasing Treasuries or agency debt (due to the scarcity issue), the Fed decides to purchase equities or ETFs direct, a la Japan, possibly even foreign debt.

9) Fed advises the government to intervene in the commodity markets — This makes sense given that one of the problems associated with QE2 was unintended inflation hitting commodity markets.

Furthermore, Ben Bernanke has already hinted that the commodity markets are currently a major spanner in any monetary policy. He famously quipped in April that the Fed cannot create more oil.

That said, intervening in commodity markets is easier said than done, and would definitely involve the cooperation of the IEA, US Energy Department and possible participation in the futures markets. That’s not to say it can’t be done. According to a paper by Stephen Cecchetti, “Was the deflation of 1930-1932 really unanticipated”  the US government intervened directly in agricultural futures markets back in the 30s in order to keep the futures curve ascending. The intention being to keep the market in contango, maintaining the expectation that prices would rise into the future.

After all if commodity futures flip out of contango, as many are now doing, financial investors might misinterpret that as a price deflation signal, leading to swift monetary outflows from commodity future markets (despite forward curves usually being perceived as shoddy forecasting tools).

Nevertheless, in a highly financialised market, the Fed certainly has an interest in keeping commodity inflation expectations high, while keeping spot prices low enough to avoid stifiling demand. From that perspective, a mandate to intervene in futures markets to maintain a contango can make sense.

*Ironically, the Cushing problem actually serves as a major advantage for the US here, since it naturally incentivises more of a contango formation in the US crude futures markets versus the global Brent market.

10) Fed and all other central banks unite to control FX volatility and hot money outflows through permanent alternatives to FX swap lines — most likely through a more significant IMF or BIS role, involving greater use of special drawing rights as a reserve currency. The point here is that this would discourage unilateral (and arguably destabilizing) policy behaviour by independent central banks faced with hot money inflows, while keeping the system balanced for US monetary policy to take effect.

11) The Fed bluffs — Don’t underestimate the power of the bluff!

Of course, there’s also Paul Krugman’s argument that in a debt deflation trap, all conventional monetary tools become redundant and all central banks end up losing credibility. (Especially if the system is intrinsically insolvent.)


Here’s a couple more options from Morgan Stanley (who also don’t expect QE3):

12) Reinvesting paydowns from MBS and agency holdings — “and using the proceeds to buy longer duration Treasuries”.

13) A modified operation twist – “in which the Fed sells shorter-duration holdings in the SOMA portfolio and buys longer-duration Treasuries. In our estimation, this would have the effect of keeping longer term yields 20-35bps lower than they ordinarily would be.”

14) Cutting interest paid to banks on reserves – “Our economist, David Greenlaw, expects that the Fed may cut IOER at some point in the coming months from 0.25% to 0% and may even consider setting a negative rate to counteract the high liquidity preference which has stymied the impact of monetary policy.”

Related links:
An important lesson from Jackson Hole 2010
– FT Alphaville
Introducing the 2011 deposit crisis
– FT Alphaville
Shadow banking – from Giffen goods to Triffin troubles
– FT Alphaville
The Fed’s secret QE equivalent
– FT Alphaville