I’ve been puzzling about the recent Fed actions, and I think there is less there than meets the eye. Don’t get me wrong, the Fed has acted. It is changing the composition of its balance sheet in the short run, absorbing MBS, and pushing out Treasuries. But it is not expanding its balance sheet. After several novel policy initiatives, it should be painfully obvious to Fed-watchers that the lack of increase in the monetary base is intentional.
The Fed is trying to influence financing in the residential mortgage market versus Treasuries, in the short run. It is not trying to stimulate the economy through expanding the monetary base.
The short-run aspect of the program hobbles it to some degree. The Fed can say that they will continue to finance in the short term indefinitely, but nothing says that louder than expanding the terms from 28 days to two years. If it’s in the agreement, the expanded length of financing will get a much bigger result than a rolling four week window. Think of it this way: the Fed might want to continue the short-term financing indefinitely, but there have been times in the past where the Fed has felt forced to abandon a plan because of global macroeconomic events (think 1986-7, when the dollar fell, then the bond market fell, then the stock market fell…). Promises are one thing, contractual terms are another.
I’m not a fan of central banking, but if we are going to have central banking, this is a time when the monetary base should be expanding, at least modestly. I think the Fed in this case is being “too clever” and needs to do a permanent injection of liquidity. If they don’t want to do that, well, let’s move back to the gold standard, and privatize monetary policy.