Fed Statements Make More Treasury Purchases Less Likely

January 16th, 2012
in Background

Econintersect:  St. Louis Federal Reserve Bank President James Bullard and Richmond Fed President Jeffrey Lacker are two Federal Reserve Bank officials Fed-sealSMALLthat have said the Fed should halt (temporarily at least) purchases of U.S. Treasury securities because of a strengthening economy.  This is in contrast to comments last week from other Fed officials, including Chicago Fed President Charles Evans and New York Fed President William Dudley, who called for continued liquidity support of the economy with the bond purchase process commonly referred to as quantitative easing (QE).  According to an article by Mark Felsenthal (Reuters) the pronouncements by Bullard, who is considered a policy centrist, and the hawkish Lacker make it more likely that the Fed will put more bond purchases on hold.

Follow up:

The FOMC (Federal Reserve Open Market Committee) conducts purchases and sales of U.S. Treasury securities to adjust the amount of currency in the financial system.  When things are heating up in the economy the FOMC can try to put a damper on potential inflation by selling Treasuries (or other securities) which removes money that could be used otherwise in banking or the broader economy.  The reason for the mention of “other securities” is that the Fed now has on its books well over $1 trillion of securities that are not the traditional U.S. Treasury paper, mostly MBS (mortgage backed securities).

If the economy is considered to be too slow, the reverse of the cooling off process can be employed and more money supplied to the economy in exchange for government debt added to the balance sheet at the Fed.  This has been done on a large scale over the past two years in an unprecedented series of scheduled QE programs.

All of the talk by Fed governors is preceding the next Federal Reserve policy meeting January 24-25.  From Reuters:

The central bank is expected to provide more information about the expected path of interest rates and perhaps lay out an explicit inflation target, but it is not expected to announce a further round of asset purchases.

The Fed cut overnight interest rates to zero in December 2008 and has bought $2.3 trillion in government and mortgage-related bonds in a further effort to spur growth after the worst recession in decades.

Several Fed officials, including the influential head of the New York Fed, have suggested in recent days that further bond buys may need to be considered, but Bullard's reticence suggests that is a debate for another day.

While the economy appeared to strengthen toward the end of last year, analysts believe growth will soften again in 2012.

If the economy does soften as 2012 progresses, there are few doubts that more purchase programs will be announced (more QE).  Some economists have expressed concern that the effectiveness of QE for strengthening the broader economy has been marginal; that the effect has been primarily to improve the liquidity of banks which have engaged in financial operations (the “Wall Street economy”) without benefit to what is often referred to as the “Main Street economy.”

Source:  Reuters (found on Econintersect Newspaper Americas page)

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