Sunday, September 27, 2009

What is the Fed thinking?

On September 23, the Fed released  a statement after the FOMC meeting:

On the economy,
"the Federal Open Market Committee met in August suggests that economic activity has picked up following its severe downturn. Conditions in financial markets have improved further,


On inflation,
"With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time............."

On monetary policies,
" The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt. The Committee will gradually slow the pace of these purchases in order to promote a smooth transition in markets and anticipates that they will be executed by the end of the first quarter of 2010. As previously announced, the Federal Reserve’s purchases of $300 billion of Treasury securities will be completed by the end of October 2009. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted."

The market seemed to interpret as a signal of taking money out of the economy the Fed's plan to "gradually" slow the pace of purchases agency mortgage-backed securities and agency debt and extend the process till 2010.

In the past, the Fed starts to hike rate and tighten money supply when it foresees an economic recovery or pick-up. Many, of late, have worried about inflationary pressure or even stagflation should the government and the Fed fail in the timing and manner of such exit plan (which has been shown to be often too slow or too late in the past). If this "gradually slower purchases of securities" is indeed the first step of a series of exit steps, I would think that the Fed deserves an applause in landing a perfect finale to this once-in-a-century rescue plan on the part of policymakers.

Obviously, this big applause is on the condition that we are really seeing the light at the tunnel of this historic financial turmoil instead of a double-dip. From what we see at this moment, I vote for the former. You?

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