Image via WikipediaBarclays Capital lays out a primer for what the Fed is really doing for monetary policy. The Fed can't drop interest rates below 0%, but there are other weapons in the Fed arsenal. Barclays Capital in their most recent Weekly Market Monitor talks in depth about the current Fed policy called Quantitative Easing. (See Help! What is Quantitative Easing?)"Without making a formal announcement, the Fed has already moved to a policy that is effectively QE. While its policy objective is still the fed funds rate, the Fed's balance sheet has more than doubled over the past three months to over $2 Trillion as it has expanded its emergency lending programs, foreign currency swap lines, and open market purchases. When the Fed began creating new lending facilities last year, it financed them by selling Treasuries, thereby keeping its balance sheet from expanding.
A few months ago, the Fed ran low on Treasuries it could sell and began to expand its
balance sheet; however, it sought to soak up or sterilize this expansion through the use of a special Treasury bill program. The Treasury sold bills and deposited the proceeds in its account with the Fed, and the Fed used the proceeds to extend loans to banks based on illiquid collateral. While the Fed's balance sheet was being grossed up, the Treasury was soaking up cash through bill issuance and systemwide liquidity was unchanged.
The Treasury program is being wound down and the expansion of Fed programs is being
financed through increases in excess bank reserves. In this case, the Fed is extending the same collateralized loans, generating excess reserves, and grossing up its balance sheet without sterilizing the transaction through the Treasury facility. Thus, the Fed is currently "printing money" and the over-provision of reserves to the banking system is far beyond what would be required to meet the FOMC's target funds rate."
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