What options does the Fed have?

Genevieve Signoret

What options does the Fed have for applying more monetary stimulus?

1. Restructure the balance sheet (“Operation Twist”): Replace short-term securities with longer-term ones, to depress long-term interest rates which, in turn (it is hoped), would spur demand for housing.
   • It can do so passively, by using funds from the $20bn it receives each month in principal payments;
   • Or actively, selling short-term securities to buy longer-term ones.
2. Communicate intentions as to the balance sheet: Announce a date (or, more radically, a rate of inflation) before which the Fed promises not let its balance sheet shrink (promises to continue reinvesting income on its portfolio holdings).
3. Enlarge the balance sheet by purchasing more securities (QE3).
   • It can do so in the amount of a pre-announced program size, as in the last two rounds.
   • Or by announcing that it will do so until inflation reaches a preannounced targeted rate.
4. Lower Interest on Excess Reserves (IOER). By lowering the rate of interest that the Fed pays commercial bank on the portion of their reserves that exceeds the legal minimum, the Fed would hope to spur banks to lend.
5. Extend the term of loans to banks.
6. Lend money directly to other entities:
   • To non-bank financial institutions, as it did during the 2007–2008 crisis.
   • To small businesses, as it did during the Great Depression.

Comment from Patrick Signoret - 2011/08/22 at 8:07 pm

Genevieve,

Do you think that Ben Bernanke will signal that the Fed has chosen one of these options in his Friday speech at Jackson Hole? Which one, or which combination?

Comment from Genevieve Signoret - 2011/08/22 at 9:05 pm

Patrick,
Bernanke at least will explain some options, at most will strongly signal FOMC intentions.
He will not announce a (surprise inter-meeting) monetary policy decision.
Option 6 is a last resort.
I expect the first FOMC move to be a restructuring of the balance sheet. I expect Bernanke to signal this at Jackson Hole.
His message may not spark a market bounce. It may disappoint inflated hopes.