Saturday, August 11, 2012

Monetary v. Financial Policy at the Fed (part 2)

Here's that quote from John Cochrane I alluded to earlier about how the Fed is doing more "financial" rather than traditional "monetary" policy: 

"Leaving aside the string of bailouts, the Fed started term lending to securities dealers. Then, rather than buy treasuries in exchange for reserves, it essentially sold treasuries in exchange for private debt. Though the funds rate was near zero, the Fed noticed huge commercial paper and securitized debt 
spreads, and intervened in those markets. There is no “the” interest rate anymore, the Fed is attempting to manage them all. Recently the Fed has started buying massive quantities of mortgage-backed securities and long-term treasury debt. Monetary policy now has little to do with “money” vs. “bonds” with all the latter lumped together. Monetary policy has become wide-ranging ļ¬nancial policy."

The point is, when you couple this quote with pretty much everything Scott Sumner has ever said, you get a picture of an institution that is wildly off course. Instead of buying short term Treasury debt for cash and using this mechanism to boost nominal spending along its previous trend, the Fed is instead trying to coax a recovery by manipulating strategic asset prices and rates of return it thinks are crucial.  

This is both dangerous and ineffective. 

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