What $75 Billion Means for the Fed

Written By Geoffrey Pike

Posted December 20, 2013

feddThe Federal Open Market Committee (FOMC) wrapped up its latest meeting on Wednesday and released its latest statement in regards to monetary policy.

For the last several meetings, the statements were very similar, reading almost identical at times.

The latest statement was different. We finally saw the beginning of a “taper”, something the markets have been anticipating for many months.

Starting in January, the Fed will “only” create $75 billion per month out of thin air, instead of the $85 billion per month we have seen over the last year. So instead of buying assets at an annual pace of just over $1 trillion, now the pace will be $900 billion per year.

To put this in context, the adjusted monetary base was around $800 billion in 2008 before the major bust became evident. So the Fed will still be creating more money on a yearly basis than all of the base money that was in existence just over 5 years ago.

The Fed is currently buying $40 billion per month of mortgage-backed securities and $45 billion per month of longer-term Treasury securities (government bonds). With the Fed’s taper, it will decrease $5 billion per month for each.

This means that the Fed will continue to bail out banks (buying mortgage-backed securities) and will continue to help Congress fund the deficit (buying U.S. government debt). It will just be at a slightly slower pace.

The other news making headlines that the markets seemed to like is that we could see the federal funds rates stay low for longer than expected.

Before, the FOMC statements said that the current rate of between 0 and .25% would remain as long as unemployment remained above 6.5% and inflation expectations stayed below 2.5%.

In the latest FOMC statement, this portion changed. It says, “The Committee now anticipates, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal.”

While this may seem like a big deal, it really isn’t at all.

The federal funds rate has been kept below .25% for about 5 years. But it is almost meaningless right now. It has nothing to do with the Fed’s monetary policy at the moment. The Fed has gone through periods of “quantitative easing” and periods of relatively stable money in the last 5 years. It doesn’t matter what the Fed does with the monetary base. The federal funds rate stays about the same.

The federal funds rate is the overnight interest rate for banks to borrow money. But since the huge expansion of the monetary base in 2008, we have also seen a huge increase in excess reserves held by banks.

Since most banks have reserves far above their minimum requirements, they have little need to borrow money overnight. They already are way in excess of their reserve requirements. Since there is little demand for overnight borrowing, the rate stays low.

For that reason, I wouldn’t focus too much on the FOMC’s policy of keeping the federal funds rate low.

The last interesting thing that deserves mention of the FOMC’s latest statement is how the members voted. In recent past meetings, we have seen one dissenting vote by Esther L. George with concerns over long-term inflation.

In the latest statement, there was also one dissenting vote, but it was a different person. Eric S. Rosengren dissented, believing that changes in the purchase program are premature. In other words, $75 billion per month in new money is not enough for him.

We are in for interesting times ahead. I don’t know if anything will change once Janet Yellen takes the helm. I do know that we are living in unprecedented times and I don’t think the Fed members really understand how to get out of the mess they have created.

Angel Publishing Investor Club Discord - Chat Now