February 2, 2009
Growing and "Using" Balance Sheets
By Cindy Ivanac-Lillig
As analysts write about the Fed’s latest actions, they refer frequently to how we are “using” our balance sheet. Here are the FOMC’s own words from January 28th: “measures…likely to keep the size of the Federal Reserve's balance sheet at a high level.”
What does this mean? For those with some background in corporate finance, this may be a real head-scratcher. Can a major U.S. retailer simply “use” its balance sheet to get out of a difficult situation? Not in the real world of business or commerce, but when it comes to monetary policy, this idea of “using” a balance sheet makes a bit more sense.
Why? Well, if you were in charge of keeping the money supply at a level where prices are stable and there is full employment, you would probably want to expand the money supply at this time -- since our economy is currently experiencing negative growth (producing less goods and services). To do this, as a good student of the Fed, you would probably want to lower the Fed Funds rate to make lending more appealing and have the money supply grow through the banking system. But since that rate is already at or very close to 0%, what else could you do to expand the money supply? You may try to simply buy things! This will help put more money into circulation. Obviously, the Fed is intervening in a strategic fashion right now, but in essence I would say that expansion through purchasing and lending is the name of the game. When you buy things, or lend money, what you purchase or the loan itself becomes an asset on your balance sheet. This is most likely what people mean when they say the Fed is “using” its balance sheet.
Now, two important questions:
• Does this expansionary policy necessarily affect M0 (monetary base) and M1? The Fed recently reported a reduction in reserves held at the Fed. Does that necessarily translate into a reduction of M0 and M1?
• And if that question isn’t provocative enough, is there a difference between “credit-easing” and “quantitative easing?” The difference may be in the art and not the science, but what do you think?
Posted by Cindy at February 2, 2009 11:15 PM
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