Wednesday Federal Reserve Action Explained – Frank Roche

Unless you were listening to CNBC or The Frank Roche Show (and I wasn’’t even on the air), the talking heads are struggling to explain the Fed action taken yesterday, 9/21/2011.  Allow me. 

As they do eight times per year, the Federal Reserve’’s Open Market Committee (FOMC) met this week to discuss the economy and adjust monetary policy accordingly.  The FOMC is a group of 12 members of the Federal Reserve.  The group includes 7 members of the Board of Governors, including the Chairman, Ben Bernanke (each governor is appointed by the President and approved by Congress), the President of the NY Fed (NY Fed is the “”trading desk”” for the Federal Reserve system), and 4 regional Federal Reserve Presidents on a rotating basis (there are 12 Fed Banks around the country, for example: the Boston Fed, the NY Fed, the San Fran Fed, the Kansas City Fed). 

The Fed has a dual mandate:  maintain stable prices (keep the rate of inflation low, …at or around 2-2.5%), and maintain full employment (unemployment rate closer to 6%). 

With the key over-night interest rate the Fed controls, the Federal Funds rate, at or near zero, the Fed has again decided to use their balance sheet as a tool to nudge longer term interest rates lower in effort to stimulate more economic activity among businesses and individuals.  We’ve heard about the Fed’s QEI, and QEII programs from the last two years.  Those were efforts to use the Fed’s balance sheet to unfreeze financial markets in the case of QE1, and to bring about lower long term interest rates to stimulate more economic output in the case of QEII.  QEI was a success.  As for QEII, success wasn’t as obvious. 

With unemployment still above 9%, the Fed is legally required to use the tools it has to try to stimulate more aggregate demand from you and me.  If successful, this effort will induce greater economic growth, which should lead to a lower unemployment rate and an economy moving towards full employment. 

Yesterday, as expected the Fed announced it will continue to keep the Federal Funds rate at 0-.25% for the foreseeable future.  In an effort to induce lower long term interest rates the Fed will begin to reposition the portfolio of securities they hold (Treasury bonds, Fannie Mae & Freddie Mac debt, Mortgage Backed Securities).  The Fed announced, without increasing their balance sheet (now approx $2t) they will buy $400b of Treasury bonds with maturities of 6 to 30 years.  They will also sell the same amount, $400b, of Treasury bonds with maturities of less than 3 years.  The intended effect, largely already priced in by the bond markets, is to lower long term interest rates to stimulate long term borrowing (think housing and capital investment), and to raise short term interest rates as a safeguard against accelerated inflationary pressures.

Financial market participants are referring to this move as the “twist”.  The Fed took similar action in the early 60’s to defend the US dollar, then part of the gold standard.  The Fed action isn’t so much of a twist, as it is a flattening of the yield curve.  For all those that think banks make easy money off the Fed, the flattening yield curve will hurt banks profitability.  Borrowing short and lending long is going to be a lot less profitable. 

The Fed is not printing new money.  The Fed is not using tax payer dollars.

In addition, the Fed said it would reinvest their earnings made from holding Mortgage Backed Securities (MBS) in an effort to support the housing market.  This is also a helping hand to both Fannie Mae, and Freddie Mac, the two government housing giants that badly skew the economics of housing to our collective detriment.  Again, this is an effort by the Fed to comply with their dual mandate of maintaining stable prices and full employment.    

Should the Fed be doing this?  I would argue no.  Three members of the FOMC voted against this latest action.  The problem for the Fed is their second mandate required by Congress:  maintaining full employment.  If their only mandate was maintaining stable prices, my guess is the Fed would be on hold right now. 

There are only a couple of places to go to get the best explanation on matters economic and related to the Fed, and the best place is… The Frank Roche Show.  Sunday’s Noon-3, RUSH Radio, 106-1.

Frank Roche

    
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Hans
Hans
13 years ago

“…the Fed is legally required to use the tools it has to try to stimulate more aggregate demand from you and me.”

Umm, Frank, my copy of the Constitution doesn’t grant the general government any authority to “stimulate me”.

With regard to economic “help” from the Fed, please reflect on the following:

Elan: “You wanna buy some death sticks?”
Obi-Wan: “You don’t want to sell me death sticks.”
Elan: “I don’t wanna sell you death sticks.”
Obi-Wan: “You want to go home and rethink your life.”
Elan: “I wanna go home and rethink my life.”

―Elan Sel’Sabagno and Obi-Wan Kenobi[src]

Death sticks were a mild hallucinogen primarily sold on Outer Rim worlds, but could be found in abundance on Coruscant. Originally developed in the illegal pharmaceutical labs of CoCo Town, they were relatively cheap and were smuggled into the clubs of cities by slythmongers. The cilona extract offered euphoria in exchange for a horrific outcome, producing a twisted version of reality enhanced by bright colors. With each dose, the user’s life was shortened, and the successive dosages took away larger chunks from a lifespan. With each successive dose, the desire for a harder reaction increased. It was thus very difficult for a youth to shake it off without medical assistance.

http://starwars.wikia.com/wiki/Death_stick