This morning the markets have responded strongly to news that the Federal Open Market Committee (FOMC) decided to expand the Federal Reserve’s holdings of Treasury securities by purchasing an additional $600 billion by the end of the second quarter of 2011. In addition, the FOMC also decided to continue to reinvest principal payments from agency debt and agency mortgage-backed securities into longer-term Treasury securities. Taken together, these decisions could result in $850 billion to $900 billion of purchases of longer-term Treasury securities by the end of the second quarter of 2011. The average purchase rate would be roughly $110 billion per month, representing about $75 billion per month associated with additional purchases and roughly $35 billion per month associated with reinvestment purchases. The purchase would be across the maturity spectrum with an average duration (weighted average life of bond cash flows) of between five and six years.
How will the purchased be conducted?
The purchases will be made by the Open Market Trading Desk (the Desk) at the Federal Reserve Bank of New York. On or around the eighth business day of each month, the Desk will publish a tentative schedule of purchases. The schedule will include a list of operation dates, settlement dates, security types to be purchased, the maturity date range of eligible issues, and an expected range for the size of each operation. Purchases will be conducted with the Federal Reserve’s primary dealers through a series of competitive auctions.
What is the objective?
The purchases are intended to “promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate”. To take the second part of the statement first, it would appear that deflation rather than inflation is a concern.
With regard to the promotion of a stronger pace of economic recovery, many market participants believe that the intention is for banks to recycle the proceeds of their sales of securities into the broader economy. When buying securities from banks the Federal Reserve credits the banks’ reserve accounts at the Federal Reserve. The banks therefore have the additional reserves to support additional lending. Under our system of fractional reserve banking the $900 billion of purchases could be multiplied many times as banks lend and take deposits while ensuring that the prescribed fraction of their liabilities are held in their reserve accounts.
Who wins?
The idea…
