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Fed Considers Unconventional Measures

April 13, 2008
During the Great Deflation Scare of 2002 -- you remember, the brief interlude between the collapse of the stock market bubble and the rise of the housing bubble -- researchers at the Fed authored a series of papers exploring "unconventional measures". These studies and other musings were reported in speeches by Bernanke and papers published on various regional Fed web sites (in an earlier piece,, I identified 14 such papers and speeches). These so-called "unconventional" measures consisted of the outright monetization of assets and, failing that, various bizarre money-crankish schemes for debasing the dollar. It looks as if these plans, and other similar ones developed since then, are now being put into effect. Last week, the Wall Street Journal reported (on their paid site) Fed Weighs Its Options in Easing Crunch.
WASHINGTON -- The Federal Reserve is considering contingency plans for expanding its lending power in the event its recent steps to unfreeze credit markets fail. Among the options: Having the Treasury borrow more money than it needs to fund the government and leave the proceeds on deposit at the Fed; issuing debt under the Fed's name rather than the Treasury's; and asking Congress for immediate authority for the Fed to pay interest on commercial-bank reserves instead of waiting until a previously enacted law permits it in 2011.
So far, the Fed has not been monetizing assets as such. They have been taking distressed debt off the balance sheet of banks and then selling an equal amount of US Treasury securities from it's own balance sheet. (However, Steve Waldman on his blog has called this covert nationalization; and the (UK) Telegraph has reported that the Fed may consider outright nationalization of insolvent banks.) But if you accept the mainstream analysis, the Fed is not increasing the monetary base because, on net, they are purchasing and selling the same quantity of securities. The article devotes considerable space to the possibility that the Fed might run out of assets on its own balance sheet, and what steps can be taken to prevent this. But why? The Fed does not want the Fed Funds rate to drop, as would happen if it made net purchases of securities from the banking system. But, in the end, the Fed does not need to swap assets for assets. In can simply purchase distressed or worthless assets and write a check on itself to pay for it. And so, further down:
Fed officials also are investigating the feasibility of the Fed issuing its own debt and using the proceeds to purchase other assets or make loans. It has never done so; the legality is unclear. Some foreign central banks, such as the Bank of Japan, do so.

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