Is the Fed admitting that they are running out of ammunition?21 June, 2012, 3:50. Posted by Zarathustra
Source: Federal Reserve Board
The Federal Reserve has cut growth forecasts and inflation forecasts while unemployment forecast is up while
doing next to nothingextending operation twist through the end of the year. This leaves a question on why the Fed is not doing more in this meeting.
Of course, a lot of people, including us, have been suggesting that asset purchases, a.k.a. quantitative easing, does not really work in this environment. It was probably useful during the financial crisis to stop things getting worse as it provided liquidity at the time when the market most needed it, but beyond that, it does not seem to be very useful.
This is not at all surprising. The burst of US housing bubble triggered a debt deflation where private sector had too much debt such that when asset prices fell, private sector would try to minimise their debts, and that would imply selling of assets, repayment of debts, default, reducing consumption and so on, which will then mean contraction of money supply and so on, thus deflationary (which is, by the way, is not good for debtors). One can go on and on to talk about this vicious cycle, but you get the gist here. Quantitative easing was an attempt to plug the hole of contracted money supply which was a result of private sector deleveraging. What it done is creating bank reserve and hope that it can stimulate lending. However, lending has nothing to do with how much excess reserve banks have.
Ben Bernanke knows this, so it seems. In the press conference, while he repeatedly said that the Fed is ready to do more if the situation warrants, he is just short of suggesting what the Fed will be doing. Of course, he wouldn’t be admitting outright that the Fed is running out of ammunition, but one can’t help feeling that he does think the Fed has done almost all he could think of. The Fed will be running out of short-term securities for maturity extension after the decision to extend the programme in this meeting, so the Fed can only do so far on that. While there are costs and risks associated with outright balance sheet expansion. So said Ben Bernanke.
So the Fed is not willing to do more at this stage, and perhaps is not able to think of something meaningful to do as well.
As Felix Salmon puts it:
Great question from Nikkei: Is the US in a liquidity trap? Bernanke doesn’t answer directly, but implies the answer is yes.
— felix salmon (@felixsalmon) June 20, 2012
That says it all.