Tag Archives: Fed

It must be impossible for the Fed to create inflation

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Hardly an hour goes by without some pundit pushing the possibility of some kind of run away inflation, with Zimbabwe and Weimar rolling off the tongues of ordinary Americans everywhere. And Congressman and candidates of all persuasions continuously lambaste the Fed for debasing the currency.

There’s no question the Fed has been trying to reflate, particularly with regard to housing. They were not going to make the mistake Japan made, so they rapidly dropped the fed funds rate to near 0%, provided unlimited bank liquidity, and then went on to buy $trillions of US government securities in an attempt to support demand and prices by adding more liquidity and further bringing down long term interest rates and mortgages. The stated and obvious intent has been to do everything they can to support a private sector credit expansion that would support prices and the aggregate demand needed to reduce unemployment.

For all practical purposes the Fed has done it all. And yet unemployment remains at depression levels of over 9% (and over 16% the way it used to be calculated not long ago) and the only thing keeping what’s called ‘inflation’ over 1% is a foreign monopolist supporting the price of crude oil.

So if inflation is this ominously lurking around every corner that requires eternal vigilance to keep from suddenly rearing its ugly head, why have all the Fed’s horses and all the Fed’s men not been able to inflate again? And why would anyone still think they can? I mean, we’re talking about college graduates with advance degrees and resources and power up the gazoo doing everything they can to reflate, and still failing after 3 long years? Not to mention the same in Japan for going on 20 years, where they have college grads with advanced degrees as well (though pretty much from the same schools).

Maybe this inflation thing is harder to get going than it looks? And what did go on in the German Wiemar republic, where if you parked a wheelbarrow full of money thieves would take the wheelbarrow and leave the money? Turns out it was those pesky war reparations that caused government deficit spending to soar to something like 50% of GDP annually, with most of that whopping deficit spending used to sell the German currency and buy foreign currency to pay their war reparations. As expected, that drove their currency down the rat hole in short order, and kept driving it down, causing that famous bout of hyper inflation that didn’t end until that policy ended. And when all that ended and policy changed the inflation stopped dead in its tracks. In one day. So how about Zimbabwe? Turns out they had a tad of civil unrest that dropped their productive capacity by about 80%, but government spending stayed high and too much spending power with too few goods and services for sale drove prices through the roof. Not to mention rumors of insiders using the local currency to buy foreign currencies for personal gain (sound familiar).

Applying this to the US to replicate the Wiemar inflation Congress would have to increase the deficit to about $8 trillion a year and then sell those dollars continuously in the market place, using them to buy the likes of yen, euro, and pounds. And replicating Zimbabwe would mean some kind of disaster that wiped out 80% of our real productive capacity and then continuing to spend federal dollars as if that never happened.

But note that it turns out these examples of hyper inflation are traced back to wildly excessive govt. deficit spending, and not actions by the Central Banks. And, in fact, from what I’ve seen those kinds of levels of deficit spending always cause inflation, no matter what the Central Bank does. For example, deficit spending and indexation of prices paid by government to various measures of inflation propagated all the great Latin American inflations of the relatively recent past, even as the Central Banks desperately hiked rates, didn’t buy securities, and, in general, did all they could to promote price stability.

China gives us an interesting contemporary data point to consider. Deficit spending in China has been running over 20% per year when you include state lending to state owned enterprises, local governments, and other entities where repayment isn’t a factor, making that lending, for all practical purposes, pretty much the same as deficit spending. The only time the US deficit spending got that high, with pretty much the same growth rates, was during World War II. And while considered high, China’s inflation seems to have peaked at about 6%, a far cry form hyper inflation, also, interestingly, much like the US during World War II. And note during World War II, the Fed was entirely accommodative, much like the the Fed is today, buying Treasury securities to keep long term rates low.

What all this tells me is that run away inflation, whatever that might mean, isn’t something hiding around every corner waiting to pounce. In fact, it takes a lot of work to get there, and not from the Fed, but from Congress. And not just what we’d call high levels of deficit spending, but ultra high levels of deficit spending.

I have no fear whatsoever of the Fed causing inflation. In fact, theory and evidence tells me their tools more likely work in reverse, due to the interest income channels. That’s because when they lower rates, they are working to remove net interest income from the private sector, and when they buy US Treasury securities (aka QE/ quantitative easing) they remove even more interest income from the economy. Remember that $79 billion in QE portfolio profits the Fed turned over to the Treasury last year? Those dollars would have otherwise remained in the economy.

So what’s the fundamental difference between what the Fed and can do and what Congress can do? The Fed can’t create net financial assets because they only buy, loan, and otherwise traffic in financial assets. Buying a bond or any other security only exchanges one financial asset for another and therefore doesn’t change the nominal (dollar) wealth of the economy. When the Fed buys a security, that security is no longer held by the economy. The Fed gets the security and the economy gets an equal dollar balance in a Fed account. The exchange is done at market prices so for all practical purposes it’s a equal exchange.

When Congress spends, however, it usually buys real goods and services, and not securities and other financial assets. So when the exchange takes place, Congress gets the real goods and services, which are not financial assets, and the economy gets dollar balances at the Fed, which are financial assets. So spending by Congress adds financial assets to the economy, to the penny, making it very different from what the Fed does.

And note that when the economy buys Treasury securities, all that happens is that the dollar balances the economy has at the Fed in what are called ‘reserve accounts’ get move to dollar balances in what are called ‘securities accounts’ at the Fed. Dollars in securities accounts and reserve accounts are all dollar financial assets. So shifting back and forth doesn’t change the dollar nominal wealth of the economy.

In conclusion, theory and evidence tell me it’s impossible for the Fed to create inflation, no matter how much it tries. The reason is because all the Fed does is shift dollars from one type of account to another, never changing the net financial assets held by the economy. Changing interest rates only shifts dollars between ‘savers’ and ‘borrowers’ and QE only shifts dollars from securities accounts to reserve accounts. And so theory and evidence tells us not to expect much change in the macro economy from these primary Fed tools, making it impossible for the Fed to create inflation.

Post Script:

And don’t be fooled by arguments centering around inflation expectations theory. That does’t hold any water either, and under close examination gets no support from theory or evidence. The only support it gets is from fundamentally flawed assumptions, which I’ll save for another discussion.

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Comments on Senator Sanders article on the Fed

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Dear Senator Sanders,

Thank you for your attention to this matter!
My comments appear below:

The Veil of Secrecy at the Fed Has Been Lifted, Now It’s Time for Change

By Senator Bernie Sanders

November 2 (Huffington Post) — As a result of the greed, recklessness, and illegal behavior on Wall Street, the American people have experienced the worst economic crisis since the Great Depression.

Not to mention the institutional structure that rewarded said behavior, and, more important, the failure of government to respond in a timely manner with policy to ensure the financial crisis didn’t spill over to the real economy.

Millions of Americans, through no fault of their own, have lost their jobs, homes, life savings, and ability to send their kids to college. Small businesses have been unable to get the credit they need to expand their businesses, and credit is still extremely tight. Wages as a share of national income are now at the lowest level since the Great Depression, and the number of Americans living in poverty is at an all-time high.

Yes, it’s all a sad disgrace.

Meanwhile, when small-business owners were being turned down for loans at private banks and millions of Americans were being kicked out of their homes, the Federal Reserve provided the largest taxpayer-financed bailout in the history of the world to Wall Street and too-big-to-fail institutions, with virtually no strings attached.

Only partially true. For the most part the institutions did fail, as shareholder equity was largely lost. Failure means investors lose, and the assets of the failed institution sold or otherwise transferred to others.

But yes, some shareholders and bonds holders (and executives) who should have lost were protected.

Over two years ago, I asked Ben Bernanke, the chairman of the Federal Reserve, a few simple questions that I thought the American people had a right to know: Who got money through the Fed bailout? How much did they receive? What were the terms of this assistance?

Incredibly, the chairman of the Fed refused to answer these fundamental questions about how trillions of taxpayer dollars were being spent.

The American people are finally getting answers to these questions thanks to an amendment I included in the Dodd-Frank financial reform bill which required the Government Accountability Office (GAO) to audit and investigate conflicts of interest at the Fed. Those answers raise grave questions about the Federal Reserve and how it operates — and whose interests it serves.

As a result of these GAO reports, we learned that the Federal Reserve provided a jaw-dropping $16 trillion in total financial assistance to every major financial institution in the country as well as a number of corporations, wealthy individuals and central banks throughout the world.

Yes, however, while I haven’t seen the detail, that figure likely includes liquidity provision to FDIC insured banks which is an entirely separate matter and not rightly a ‘bailout’.

The US banking system (rightly) works to serve public purpose by insuring deposits and bank liquidity in general. And history continues to ‘prove’ banking in general can work no other way.

And once government has secured the banking system’s ability to fund itself, regulation and supervision is then applied to ensure banks are solvent as defined by the regulations put in place by Congress, and that all of their activities are in compliance with Congressional direction as well.

The regulators are further responsible to appropriately discipline banks that fail to comply with Congressional standards.

Therefore, the issue here is not with the liquidity provision by the Fed, but with the regulators and supervisors who oversee what the banks do with their insured, tax payer supported funding.

In other words, the liability side of banking is not the place for market discipline. Discipline comes from regulation and supervision of bank assets, capital, and management.

The GAO also revealed that many of the people who serve as directors of the 12 Federal Reserve Banks come from the exact same financial institutions that the Fed is in charge of regulating. Further, the GAO found that at least 18 current and former Fed board members were affiliated with banks and companies that received emergency loans from the Federal Reserve during the financial crisis. In other words, the people “regulating” the banks were the exact same people who were being “regulated.” Talk about the fox guarding the hen house!

Yes, this is a serious matter. On the one hand you want directors with direct banking experience, while on the other you strive to avoid conflicts of interest.

The emergency response from the Fed appears to have created two systems of government in America: one for Wall Street, and another for everyone else. While the rich and powerful were “too big to fail” and were given an endless supply of cheap credit, ordinary Americans, by the tens of millions, were allowed to fail.

The Fed necessarily sets the cost of funds for the economy through its designated agents, the nations Fed member banks. It was the Fed’s belief that, in general, a lower cost of funds for the banking system, presumably to be passed through to the economy, was in the best interest of ‘ordinary Americans.’ And note that the lower cost of funds from the Fed does not necessarily help bank earnings and profits, as it reduces the interest banks earn on their capital and on excess funds banks have that consumers keep in their checking accounts.

However, there was more that Congress could have done to keep homeowners from failing, beginning with making an appropriate fiscal adjustment in 2008 as the financial crisis intensified, and in passing regulations regarding foreclosure practices.

Additionally, it should also be recognized that the Fed is, functionally, an agent of Congress, subject to immediate Congressional command. That is, the Congress has the power to direct the Fed in real time and is thereby also responsible for failures of Fed policy.

They lost their homes. They lost their jobs. They lost their life savings. And, they lost their hope for the future. This is not what American democracy is supposed to look like. It is time for change at the Fed — real change.

I blame this almost entirely on the failure of Congress to make the immediate and appropriate fiscal adjustments in 2008 that would have sustained employment and output even as the financial crisis took its toll on the shareholder equity of the financial sector.

Congress also failed to act with regard to issues surrounding the foreclosure process that have worked against public purpose.

Among the GAO’s key findings is that the Fed lacks a comprehensive system to deal with conflicts of interest, despite the serious potential for abuse. In fact, according to the GAO, the Fed actually provided conflict of interest waivers to employees and private contractors so they could keep investments in the same financial institutions and corporations that were given emergency loans.

The GAO has detailed instance after instance of top executives of corporations and financial institutions using their influence as Federal Reserve directors to financially benefit their firms, and, in at least one instance, themselves.

For example, the CEO of JP Morgan Chase served on the New York Fed’s board of directors at the same time that his bank received more than $390 billion in financial assistance from the Fed. Moreover, JP Morgan Chase served as one of the clearing banks for the Fed’s emergency lending programs.

This demands thorough investigation, and in any case the conflict of interest should have been publicly revealed at the time.

Getting this type of disclosure was not easy. Wall Street and the Federal Reserve fought it every step of the way. But, as difficult as it was to lift the veil of secrecy at the Fed, it will be even harder to reform the Fed so that it serves the needs of all Americans, and not just Wall Street. But, that is exactly what we have to do.

Yes, I have always supported full transparency.

To get this process started, I have asked some of the leading economists in this country to serve on an advisory committee to provide Congress with legislative options to reform the Federal Reserve.

Here are some of the questions that I have asked this advisory committee to explore:

1. How can we structurally reform the Fed to make our nation’s central bank a more democratic institution responsive to the needs of ordinary Americans, end conflicts of interest, and increase transparency? What are the best practices that central banks in other countries have developed that we can learn from? Compared with central banks in Europe, Canada, and Australia, the GAO found that the Federal Reserve does not do a good job in disclosing potential conflicts of interest and other essential elements of transparency.

Yes, full transparency in ‘real time’ would serve public purpose.

2. At a time when 16.5 percent of our people are unemployed or under-employed, how can we strengthen the Federal Reserve’s full-employment mandate and ensure that the Fed conducts monetary policy to achieve maximum employment? When Wall Street was on the verge of collapse, the Federal Reserve acted with a fierce sense of urgency to save the financial system. We need the Fed to act with the same boldness to combat the unemployment crisis.

Unfortunately employment and output is not a function of what’s called ‘monetary policy’ so what is needed from the Fed is full support of an active fiscal policy focused on employment and price stability.

3. The Federal Reserve has a responsibility to ensure the safety and soundness of financial institutions and to contain systemic risks in financial markets. Given that the top six financial institutions in the country now have assets equivalent to 65 percent of our GDP, more than $9 trillion, is there any reason why this extraordinary concentration of ownership should not be broken up? Should a bank that is “too big to fail” be allowed to exist?

Larger size should be permitted only to the extent that it results in lower fees for the consumer. The regulators can require institutions that wish to grow be allowed to do so only in return for lower banking fees.

4. The Federal Reserve has the responsibility to protect the credit rights of consumers. At a time when credit card issuers are charging millions of Americans interest rates between 25 percent or more, should policy options be established to ensure that the Federal Reserve and the Consumer Financial Protection Bureau protect consumers against predatory lending, usury, and exorbitant fees in the financial services industry?

Banks are public/private partnerships chartered by government for the further purpose of supporting a financial infrastructure that serves public purpose.

The banks are government agents and should be addressed accordingly, always keeping in mind the mission is to support public purpose.

In this case, because banks are government agents, the question is that of public purpose served by credit cards and related fees, and not the general ‘right’ of shareholders to make profits.

Once public purpose has been established, the effective use of private capital to price risk in the context of a profit motive should then be addressed.

5. At a time when the dream of homeownership has turned into the nightmare of foreclosure for too many Americans, what role should the Federal Reserve be playing in providing relief to homeowners who are underwater on their mortgages, combating the foreclosure crisis, and making housing more affordable?

Again, it begins with a discussion of public purpose, where Congress must decide what, with regard to housing, best serves public purpose. The will of Congress can then be expressed by the institutional structure of its Federal banking system.

Options available, for example, include the option of ordering that appraisals and income statements not be factors in refinancing loans originated by Federal institutions including banks and the Federal housing agencies. At the time of origination the lenders calculated their returns based on mortgages being refinanced as rates came down, assuming all borrowers would be eligible for refinancing. The financial crisis and subsequent failure of policy to sustain employment and output has given lenders an unexpected ‘bonus’ through a ‘technicality’ that allows them to refuse requests for refinancing at lower rates due to lower appraisals and lower incomes.

6. At a time when the United States has the most inequitable distribution of wealth and income of any major country, and the greatest gap between the very rich and everyone else since 1928, what policies can be established at the Federal Reserve which reduces income and wealth inequality in the U.S?

The root causes begin with Federal policy that has resulted in an unprecedented transfer of wealth to the financial sector at the expense of the real sectors. This can easily and immediately be reversed, which would serve to substantially reverse the trend income distribution.

Sincerely,

Warren Mosler

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News recap comments

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The news flow from last week was so voluminous it was nearly impossible to process. For good measure I want to start today’s commentary with a simple recap of what happened.

On the negative side –

· Greece called a referendum and threw bailout plans up in the air taking Greek 2yrs from 70% to 90% or +2000bps.
· Italian 10yr debt collapsed 40bps with spreads to Germany out 70bps. The moves were far larger in the 2yr sector.
· France 10y debt widened 25bps to Germany. At one point spreads were almost 40 wider.
· Italian PMI and Spanish employment data were miserable.
· German factory orders plunged 4.3 percent on the month.
· The planned EFSF bond for 3bio was pulled.
· Itraxx financials were +34 while subs were +45.
· Draghi predicted a recession for Europe along with disinflation.
· The G20 was flop – there was no agreement on IMF involvement in Europe.
· The US super committee deadline is 17 days away with no clear agreement.
· The 8th largest US bankruptcy in history took place.
· US 10yr and 30yr rallied 28bps, Spoos were -2.5%, the Dax was -6% and EURUSD was -3%.
· German CDS was up 16bps on the week.

On the positive side –

· The Fed showed its hand with tightening dissents now gone and an easing dissent in place.

Too bad what they call ‘easing’ at best has been shown to do nothing.

· The Fed’s significant downside risk language remained intact.

Downside risks sound like bad news to me.

· In the press conference Ben teed up QE3 in MBS space.

Which at best have been shown to do little or nothing for the macro economy.

· US payrolls, claims, vehicle sales and productivity came in better than expected.

And the real output gap if anything widened.

· S&P earnings are coming in at +18% y/y with implied corporate profits at +23 percent q/q a.r.

Reinforces the notion that it’s a good for stocks, bad for people economy.

· Mortgage speeds were much faster than expectations suggesting some easing refi pressures.

And savers holding those securities saw their incomes cut faster than expected.

· The ECB cut 25bps and indicated a dovish forward looking stance.

Which reduced euro interest income for the non govt sectors

· CME Margins were reduced.

Just means volatility was down some.

· There was a massive USDJPY intervention which may be a precursor to a Swiss style Japanese policy easing.

Which, for the US, means reduced costs of imports from Japan, which works against US exports, which should be a good thing for the US as it means for the size govt we have, taxes could be lowered to sustain demand, but becomes a bad thing as our leadership believes the US Federal deficit to be too large and so instead we get higher unemployment.

· The Swiss have indicated they want an even weaker CHF – possibly EURCHF 1.40.

When this makes a list of ‘positives’ you know the positives are pretty sorry

· The Aussies cut rates 25bps

Cutting net interest income for the economy.

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Payrolls and a Fed rant

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Utter failure of policy.

The Fed was certain it knew what Japan had done wrong and wasn’t going to make THOSE mistakes.

So it

Cut rates much more aggressively.

Said it would do whatever it takes.

Figured out how to do its job as liquidity provider after only 6 months of alphabet soup programs.

Did heaps of Quantitative Easing.

Did the twist.

And now, realizing its done about all it can do, says monetary policy can’t do it all.

And still fails to recognize publicly the actual problem is the budget deficit is way too small.

And doesn’t directly inform Congress that

there is no such thing as a solvency problem,

the Fed controls government interest rates, and not the market,

there is no long term deficit problem with regards to finance,

the only thing we owe China is a bank statement,

Quantitative Easing and rate cuts remove interest income from the economy, which allows the deficit to be that much larger,

etc.

as we continue to go the way of Japan.


Karim writes:

Some improvement around the edges but the larger narrative is employment rising only at a rate fast enough to keep the unemployment rate stable (not higher or lower)

  • NFP 80k with net revisions 102k
  • Unemp rate down to 9% from 9.1%
  • Average hourly earnings 0.2% and aggregate hours 0.1% barely ok for labor income once adjusted for inflation
  • Weather may have played a small role as construction employment turned from +27k to -20k
  • Diffusion index improved from 56.7 to 60.7; while encouraging in that the majority of industries are adding jobs, doesn’t say or mean they are necessarily adding jobs at an increasing rate
  • Other positives are median duration of unemployment falling from 22.2 weeks to 20.8 weeks and U6 measure falling from 16.5% to 16.2%
  • Don’t think this would have a big impact on the new Fed forecasts we saw the other day

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President Obama entering the fray

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More of the blind leading the blind. The one thing they all agree on, at great expense to global well being, is the budget deficits are all too large and the need for shared sacrifice and all that.

No chance for anything constructive to come out of any of this.

And these masters of their money machines don’t even know how to inflate, as they all desperately try to inflate with their versions of quantitative easing, which, functionally, is just another demand draining tax.

*DJ Merkel, Obama Discussed How To Boost EFSF Firepower Without ECB
*DJ Obama To Merkel: We Are Totally Invested In Your Success – Source
*DJ Geithner, Schaeuble May Meet To Discuss IMF Role In Euro Crisis -Source

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The Euro Zone Race to the Bottom

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While the symptoms get continuous attention as they get threatening enough, the underlying cause-the austerity- does not.

The euro zone, like most of the world, is failing to meet its further economic objectives because of a lack of aggregate demand.

And in the euro zone, the fundamental problem is that the member nations, as credit sensitive ‘currency users’ are necessarily pro cyclical in a downturn, much like the US states, and therefore incapable of independently meeting their further economic objectives.

So even as the euro zone struggles to address it’s solvency crisis that threatens the union itself as well as at least part of what remains of the global financial architecture, the underlying shortage of euro net financial assets continues to undermine output and employment, with GDP growth now forecast to fall to 0 with a chance of going negative in the current quarter.

What this means is that without adopting an alternative to the current policy of applying enhanced austerity as the means of addressing the solvency issue, it all remains in a very ugly downward spiral with social collapse far less than impossible.

So yes, the solvency issue can continue to be managed by the ECB, the issuer of the euro, continuing to buy national government debt as needed. But that doesn’t add net euro financial assets to the economy. It merely shifts financial assets held by the economy from the debt of the national governments to deposits at the ECB. So it does nothing with regards to output, employment, inflation, etc. as recent history has shown.

In fact, nothing the world’s central banks do adds net financial assets to their economies. And much of what they do actually removes net financial assets from their economies, making things worse. Note that last year the Fed turned over some $79 billion in profits to the Treasury. Those profits came from the economy, having been removed from the economy by the Fed’s policy of quantitative easing, which the old text books rightly used to call a tax.

And meanwhile, the imposed austerity that accompanies the bond purchases does directly alter output and employment- for the worse.

Additionally, for all practical purposes, there is universal global support for austerity as the means supporting global output and employment.

So even if the euro zone gets the solvency issue right, with the ECB writing the check to remove all funding constraints, the ongoing austerity will continue to depress the real economies.

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Macro Curve Considerations

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By the end of QE2 the curve had adjusted to the Fed having taken out pretty much all of the new supply out to 10 years.

After QE2 the supply out to 10 years started to be replenished auction by auction.

This was quickly followed by twist which began working to remove supply from the long end and add it to the short end.

The net is an ongoing multi trillion shift taking supply out of the long end and adding it to the short end that will continue to be a major influence on spreads.

Additionally, the Fed is seeing no material evidence of any monetary derived inflation, credit expansion, escalating inflation expectations (not that they actually matter), etc. and they are also seeing the global economy gradually slowing, and the euro zone imploding. So higher rates from the Fed remain a highly unlikely scenario.

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Bernanke: No Plans to Add New Stimulus Measures Now

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More evidence of the suspected understanding with China- they resumed buying US Tsy secs in return for no more QE:

The U.S. economy “has been doing worse than expected” and Beijing needs to “seriously assess” possible risks to its vast holdings of American debt, said Yu Bin, an economist in the Cabinet’s Development Research Center.

Yu expressed concern about a possible third round of Fed purchases of government bonds, known as “quantitative easing” or QE. He said that might hurt China by depressing the value of the dollar and driving up prices of commodities needed by its industries.

Bernanke: No Plans to Add New Stimulus Measures Now

July 14 (Reuters) — Federal Reserve Chairman Ben Bernanke backed away slightly from promising a third round of stimulus measures, telling a Senate panel Thursday that the central bank “is not prepared at this point to take further action.

The comments during his second day of congressional testimony sent the US dollar higher and caused stock to pare their gains.

On Wednesday, Bernanke suggested to a House panel that the Fed was ready to take further steps to boost the flagging US economy. That sent stocks soaring and pushed the dollar lower.

But on Thursday, Bernanke seemed to back away a bit from that plan.

“The situation is more complex,” he told the Senate Banking Committee. “Inflation is higher…We are uncertain about the near-term developments in the economy. We would live to see if the economy does pick up. We are not prepared at this point to take further action.”

He also said a third round of stimulus may not be that effective.

Bernanke also repeated his warning that a U.S. debt default would be devastating for the U.S. and the global economy.

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Fed Turns Over Record $78.4 Billion Profit to Treasury

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And not even a hint they removed even more than that much interest income from the private sector.

(the $78.4 billion is after expenses)

Fed Turns Over Record $78.4 Billion Profit to Treasury

By: Reuters

The Federal Reserve reported Monday its earnings jumped by more than 50 percent in 2010 to a record $80.9 billion on its massive holdings of securities, and it is turning the bulk of it over to the U.S. Treasury Department.

The $78.4 billion that the Fed is remitting to Treasury is also a record and is $31 billion more than a year earlier. In 2009 the Fed had net income of $53.4 billion.

The Fed’s portfolio has ballooned to $2.16 trillion, roughly triple its size before the financial crisis, as it purchased securities including U.S. government debt and mortgage-linked bonds in a move to drive down borrowing costs and stimulate the economy.

“The increase was due primarily to increased interest income earned on securities holdings during 2010,” the U.S. central bank said in releasing preliminary unaudited results.

Audited results will be issued in the spring and may show some changes, Fed officials indicated.

After driving overnight interest rates close to zero percent in December 2008, the Fed bought $1.7 trillion of longer-term Treasury and mortgage-related bonds as a supplement to its pledge to keep overnight rates near zero for a long time.

It followed that up late last year with a new $600 billion bond-buying program — again intended to spur growth by pumping liquidity into the economy. That program ends at mid-year.

The Fed turns over profits to the Treasury annually and has never posted a loss. But the central bank took a number of extraordinary actions during and after the 2007-2009 financial crisis that critics say may have left it with some poor-quality holdings.

Doubts on All Sides

Critics fault the Fed on several scores, with some claiming its actions have sown the seeds for a potential flare-up in inflation and others saying it has put the central bank at risk of destabilizing losses when it sells down its holdings.

If credit losses were to pile up, those criticisms could mount.

In addition, some foreign governments have charged that the Fed’s easy money policies could weaken the dollar and spark a round of competitive currency devaluations.

Fed officials who briefed reporters said asset sales would be part of a so-called “exit strategy” from loose monetary policy, but only once the economy was on a sound footing. That means sales of the securities may be some way down the road, they added.

A Fed official said that if the central bank had to make sales and take some losses, it could always scale back the amount it remits to the Treasury. But there is no mechanism in place for it to get past remittances returned by the Treasury.

In testimony to Congress on Friday, Fed Chairman Ben Bernanke gave no sign the Fed was ready start scaling back its bond purchase program.

Nor did the Fed chief give any hints about further buying beyond the June deadline for the $600 billion program.

The Fed said its 2010 income included $76.2 billion in income on securities bought through open market operations, including Treasury and mortgage-linked debt, $7.1 billion from limited liability companies created in response to the financial crisis, $2.1 billion in interest income from credit extended to American International Group and $1.3 billion of dividends on preferred interests in AIA Aurora and ALICO Holdings.

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FMOC Minutes

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New Forecasts (central tendency and range of forecasts) in Table 1 below: Long-Run inflation forecast of 1.6-2.0% is basically their target; 2011 and 2012 unemployment forecasts revised up by 0.6-0.7%. Note that low-end of GDP forecast for 2011 is 2.5%. This is above many other forecasters.


Interesting Observations from FRB Staff; Outlook revised up, basically on assumption of improved financial conditions; and in turn inflation higher due to less slack and weaker $

The staff revised up its forecast for economic activity in 2011 and 2012. In light of asset market developments over the intermeeting period, which in large part appeared to reflect heightened expectations among investors that the Federal Reserve would undertake additional purchases of longer-term securities, the November forecast was conditioned on lower long-term interest rates, higher stock prices,
and a lower foreign exchange value of the dollar than was the staff’s previous forecast.

The downward pressure on inflation from slack in resource utilization was expected to be slightly less than previously projected, and prices of imported goods were anticipated to rise somewhat faster.

FOMC Members-Recap of debate of pros/cons of LSAPs; sizing LSAPs; and setting an inflation target, and setting a long-term interest rate target

Although participants considered it quite unlikely that the economy would slide back into recession, some noted that continued slow growth and high levels of resource slack could leave the economic expansion vulnerable to negative shocks. In the absence of such shocks, and assuming appropriate monetary policy

They do assume what they do has quite a bit of influence over the outcomes.

participants’ economic projections generally showed growth picking up to a moderate pace and the unemployment rate declining somewhat next year. Participants generally expected growth to strengthen further and unemployment to decline somewhat more rapidly in 2012 and 2013.

Several noted that the recent rate of output growth, if continued, would more likely be associated with an increase than a decrease in the unemployment rate.

While underlying inflation remained subdued, meeting participants generally saw only small odds of deflation, given the stability of longer-term inflation expectations

They remain steeped in inflation expectations theory as previously discussed.

and the anticipated recovery in economic activity.

Most saw the risks to growth as broadly balanced, but many saw the risks as tilted to the downside. Similarly, a majority saw the risks to inflation as balanced; some, however, saw downside risks predominating while a couple saw inflation risks as tilted to the upside.

Participants also differed in their assessments of the likely benefits and costs associated with a program of purchasing additional longer-term securities in an effort to provide additional monetary stimulus, though most saw the benefits as exceeding the costs in current circumstances. Most participants judged that a program of purchasing additional longer-term securities would put downward pressure on longer-term interest rates and boost asset prices; some observed that it could also lead to a reduction in the foreign exchange value of the dollar. Most expected these changes in financial conditions to help promote a somewhat stronger recovery in output and employment while also helping return inflation, over time, to levels consistent with the Committee’s mandate. In addition, several participants argued that the stimulus provided by additional securities purchases would help protect against further disinflation and the small probability that the U.S. economy could fall into persistent deflation–an outcome that they thought would be very costly. Some participants, however, anticipated that additional purchases of longer-term securities would have only a limited effect on the pace of the recovery; they judged that the economy’s slow growth largely reflected the effects of factors that were not likely to respond to additional monetary policy stimulus and thought that additional action would be warranted only if the outlook worsened and the odds of deflation increased materially. Some participants noted concerns that additional expansion of the Federal Reserve’s balance sheet could put unwanted downward pressure on the dollar’s value in foreign exchange markets. Several participants saw a risk that a further increase in the size of the Federal Reserve’s asset portfolio, with an accompanying increase in the supply of excess reserves and in the monetary base, could cause an undesirably large increase in inflation.

This flies in the face of any understanding of banking and actual monetary operations, as well as recent Fed research.

However, it was noted that the Committee had in place tools that would enable it to remove policy accommodation quickly if necessary to avoid an undesirable increase in inflation.


Participants expressed a range of views about the potential costs and benefits of quantifying the Committee’s interpretation of its statutory mandate to promote price stability by adopting a numerical inflation objective or a target path for the price level. In the end, participants noted that the longer-run projections contained in the Summary of Economic Projections, which is released once per quarter in conjunction with the minutes of four of the Committee’s meetings, convey considerable information about participants’ assessments of their statutory objectives. Participants discussed whether it might be useful for the Chairman to hold occasional press briefings to provide more detailed information to the public regarding the Committee’s assessment of the outlook and its policy decision making than is included in Committee’s short post-meeting statements.


In their discussion of the relative merits of smaller and more frequent adjustments versus larger and less frequent adjustments in the Federal Reserve’s intended securities holdings, participants generally agreed that large adjustments had been appropriate when economic activity was declining sharply in response to the financial crisis. In current circumstances, however, most saw advantages to a more incremental approach that would involve smaller changes in the Committee’s holdings of securities calibrated to incoming data.


Finally, participants discussed the potential benefits and costs of setting a target for a term interest rate. Some noted that targeting the yield on a term security could be an effective way to reduce longer-term interest rates and thus provide additional stimulus to the economy. But participants also noted potentially large risks, including the risk that the Federal Reserve might find itself buying undesirably large amounts of the relevant security in order to keep its yield close to the target level.

No mention at all of the interest income channels, which act to reduce interest income in the economy as rates fall.

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