2008-03-11interfluidity.com

``the Fed is conducting monetary policy on the asset side of the balance sheet. This is an innovation of the Bernanke Fed. Conventionally, monetary policy is about managing the quantity of the central bank's core liability, currency outstanding. When the Fed wants to loosen, it expands its liabilities by issuing cash in exchange for securities. When it wants to tighten, it redeems cash for securities, reducing Fed liabilities. The asset side is conventionally an afterthought, "government securities". But the Bernanke Fed has branched out. It has sought to lend against a wide-range of assets, actively seeking to replace securities about which the market seems spooked with safe-haven Treasuries on bank balance sheets without creating new cash. By doing this, the Fed hopes to square the circle of helping banks through their "liquidity crisis" without provoking a broad inflation.''

Steve Waldman's excellent analysis of the situation (from a few days ago (via Mish, via Krugman). Basically the Fed is trying to have its cake and eat it too, by conducting policy on the asset side of the balance sheet. Note that this isn't too innovative, as the ECB has been doing this in a big way for months. But the Fed is supposed to be more responsible; look less panicky, and defend the soundness of the dollar.

This move achieves none of the above; however it does ameliorate immediate cash crunch pressures of banks. A big thing it doesn't do, however, is solve the real problem: solvency. So the Fed is just forestalling the inevitable (perhaps until a Democrat gets into office?).


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