Fed Weighs Options on What to Do Next
Appearing before the House Financial Services Committee yesterday, Fed Chairman Ben Bernanke signaled that the Fed was keeping all options on the table should the economy need another round of monetary stimulus. Bernanke said that the "economy still needs a good deal of support" right now given the slow recovery in home prices and 9.2 percent unemployment--in addition, as he mentioned, to the threat that future deficits and debt pose to interest rates if left unaddressed.
At the same time, however, Bernanke noted the Fed would be prepared to move in the opposite direction if conditions warrant, exiting from the extraordinary measures employed so far to buttress the economy since the recession began if inflation picks up faster than expected. Internally, the Fed is far from unanimous about what to do next, with some members of the Federal Open Market Committee (FOMC)--the Fed's decision making body--calling for additional support if growth continues to slip while others, including Dallas Federal Reserve President Richard Fisher, are worried about a rising risk of inflation.
CRFB has continued to track the Fed's actions on Stimulus.org, where we catalog how the Fed has increased the size of its balance sheet from about $850 billion before the recession to roughly $2.9 trillion right now. In the wake of the panic of the financial crisis in the fall of 2008, the Fed created a number of new lending facilities--such as the Term Auction Facility and the Money Market Mutual Fund Liquidity Facility--to provide liquidity in the face of frozen financial markets.
Many of these facilities have already expired, but there are a few other actions that the Fed has taken that are ongoing. Right after the government placed Fannie Mae and Freddie Mac under conservatorship the Fed began buying mortgage-backed securities and Fannie and Freddie debt. These purchases rose gradually to a peak of about $1.3 trillion in May 2010, then declined to about $1 trillion. However, since August of last year, the decline in these purchases--that is, the amount of debt and MBSs that have matured--have been reinvested in Treasury securities to keep the size of the balance sheet from shrinking. That move, combined with the $600 billion of additional Treasury purchases that took place between November and June, constitutes QE2.
QE3 would likely look similar to QE2. As of right now, the Fed is still reinvesting maturing MBSs into Treasuries, so its balance sheet is holding steady. Which direction it heads next--and by how much--will be up to Chairman Bernanke and the rest of the FOMC. Certainly, a few more weak jobs reports and moderating inflation expectations could raise the likelihood of another round of quantitative easing.