There's been some good conversation in the comments. I thought I'd pull out a few of my favorite bits.
The Fed's Balance Sheet Constraint
The interesting point that no one has commented on is the existence of a Fed balance sheet constraint on limits to the outstanding TAF.
The Fed is limited by the size of the liability side. It doesn't 'force feed' currency note into the system beyond the demand of the banks and the public for currency. And it has no room to expand bank reserve balances in aggregate of it wants to maintain control over the level of the funds rate. That's why it's 'sterilizing' now.
So the upper limit to TAF is essentially the size of the Fed balance sheet now, allowing for natural growth in currency demands of the banks and the public.
Beyond that, the Fed couldn't 'sterilize' by selling other assets. It would have to start issuing its own liabilities, such as the sterilization bonds issued by the PBOC used to offset their foreign exchange purchases.
Looking at the March 6 Factors Affecting Reserve Balances, in addition to the already announced TAF and repo programs, the Fed could initiate somewhere between $500 and $600B more in "sterilized interventions" (as Paul Krugman first pointed out these are) before it would have to issue bonds rather than selling existing assets.
There's more discussion of this point over at Brad Setser's (in the comments section).
Update: The Fed announced this morning that it will use up $200B more of that capacity via a "Term Securities Lending Facility". After the FAF expansion, repo program, and TSLF, the Fed will have between $300B and $400B in remaining sterilization capacity, unless it issues bonds directly. Paul Krugman, John Jansen, jck at Alea, Yves Smith, Michael Shedlock, Free Exchange, Justin Fox, Zero Beta (and see this!) comment.
Why the special repo program?
Why did the Fed announced the new repo program rather than just more dramatically expand TAF?
livingston guy offers an explanation:
The new repo line... is nothing more than the TAF for the brokers who dont have access to the TAF. Essentially, a Merrill wants to have the same access to liquidity as JPMorgan but doesn't have it in the current framework of TAF which is only available to depositories. The new repo line just makes the same facility available to Merrill.
So the repo program can be looked at as a partial implementation of what Thomas Palley suggests. (In a pinch, apparently the Fed can lend directly to whomever it deems necessary, but that power has never been used. See David Wessel, "Analysts: Rate Cuts May Not Be Enough", ht Mark Thoma.)
Update: Livingston Guy wrote on Sunday, and was referring to the expanded repo program announced Friday, not the TSLF program announced Tuesday. However, both the expanded repo program and TSLF are available to primary dealers, whereas TAF is accessible only to depository institutions.
The /Price Spiral
Len writes...
[Regarding] a widely held misconception; namely that "inflation is the debtors friend". That IS kind of the way it worked during the Carter inflation as unions, now largely powerless due globalization, were largely able negotiate wage hikes rapidly enough to stay more or less even with inflation, creating the famous wage/price spiral which made debt an ever shrinking entity to the detriment of lenders. Nowadays we have just the /price part of that spiral, wages have been flat to negative in real terms for years. Without a means of increasing his income along with the inflating currency, the debtors debts in fact, instead of looking smaller, look ever larger as his required spending for necessities crowds out available funds for debt service, hastening insolvency.
Compare to a recent speech by Janet Yellen, President of the San Francisco Fed (via WSJ Real Time Economics):
Even so, I expect both total and core inflation to moderate over the next few years... This... assumes that inflation expectations will remain well-anchored, as they have been, and also that workers will not through their bargaining offset the real losses resulting from higher food and energy prices.
Things look different if you're a central banker.
- 11-Mar-2008, 10:45 a.m. EDT: Added update re "Term Securities Lending Facility". Attributed observation that these are sterilized interventions to Paul Krugman directly, rather than only implicitly via a link.
- 11-Mar-2008, 10:55 a.m. EDT: Cleaned up awkward wording introduced by reattribution in previous update.
- 11-Mar-2008, 11:05 a.m. EDT: Removed a redundant "in the comments". Sheesh.
- 11-Mar-2008, 1:05 p.m. EDT: Added Yves Smith to list of TSLF commenters.
- 11-Mar-2008, 2:55 p.m. EDT: Added Michael Shedlock to list of TSLF commenters.
- 11-Mar-2008, 3:55 p.m. EDT: Added update explaining that LG's comments were wrt repos, not TSLF. Added Free Exchange, Justin Fox, and Zero Beta to list of TSLF commenters.
| Steve Randy Waldman — Tuesday March 11, 2008 at 1:06am | permalink |
"The Fed isn't targeting treasury/agency spreads directly. The objective of the TAF operation is to ameliorate the deterioration in LIBOR/fed funds spreads. It is targeting interbank liquidity directly – not the solvency or liquidity of the agencies. To do this, it's getting money into the hands of those banks that are having difficulty in the unsecured interbank market, but have collateral that is acceptable at the Fed under TAF requirements (essentially the same as discount window requirements). It turns out that much of this acceptable collateral is agency related.
The TAF operation is obviously very different from FX intervention. It is not the role of foreign central banks to provide US dollar interbank liquidity to the market; nor is it their role to ‘help' treasury/agency spreads via their FX operations. The macroeconomic implications of a central bank that uses its monetary base to fund FX reserves (e.g. China) is very different than that of a CB that uses it to fund domestic intermediation (e.g. the Fed). Accordingly the analysis of materiality may be quite different. Given the short term interbank liquidity conditions that are the target of TAF, the effect of a $ 200 billion intervention may be significant in terms of short term money market liquidity conditions. Given the FX conditions that are the target of China's intervention, the effect of $ 1.5 trillion may be significant in term of these rates, and given the mostly term instruments that are involved in the asset allocation, the result of investing $ 1.5 trillion in US and other currencies may be significant in terms of its effect on term interest rates.
But the Fed is not targeting term interest rates with TAF. It is targeting the LIBOR/Fed funds spread. There may be some moderate and welcome derivative effect on terms yields, but this is not the primary objective of the TAF exercise.
Finally, the comparison of TAF sterilization and FX sterilization is interesting, but a footnote to the TAF operation. Sterilization is a normal central bank operation, whatever the asset activity is that results in its necessity. Whether it's the Fed extending TAF funds, or PBOC buying FX, both banks must take deliberate offsetting steps in order to avoid inadvertently increasing the level of domestic bank reserves held with them. CBs must have tight control over their liability structures and ensure their asset activity doesn't interfere with this. Hence – sterilization - whatever the source of its necessity. One exceptional aspect - should the Fed end up increasing the size of the TAF operation beyond the size of the Fed balance sheet itself (roughly $ 700 billion), it may have to start issuing sterilization bills like the PBOC in order to switch sterilization management from the asset side to the liability side – thereby increasing the size of the Fed balance sheet while still controlling the size of the monetary base.