Wouldn't encouraging banks to move money from reserves parked at the Fed into the economy further exacerbate any inflation issues? As for your answer on shrinking the balance sheet when their SOMA portfolio matures, I'm sorry for not seeing your question. Of course it would. But how would this reduce the amount of money in the system? Additionally, if they stop adding to their balance sheet, what do you think will happen to the market? Ie, if they cancel throwing $85B into the market every month, what do you anticipate will happen?
Thank you for bringing the discussion back to this. I agree 99%. The only 1% I would point out is that Japan has been running trade deficits the last few months, if memory serves. That changes the dynamic there considerably.
Again, I don't see how you are not understanding this: when a bond/MBS in SOMA matures/paysoff, the money comes out of the money supply to replace the security on the Fed Balance Sheet: the money supply decreases. As for what happens when they stop buying treasuries? My personal belief as a former treasuries trader and a current global macro trader: rates go up and equities go up: not because there's no buyer, but because the Fed is signaling (or, likely, confirming) that we are in good times again. (I'm sorry I really don't want to move forward with the side tracked discussion about MBS; I hate the freaking MBS space - it's why I stopped trading it at some point in my career; It's a really complicated area that's a LOT more liquid that most people think (in fact, just below treasuries), but I'm sick of talking about it. I think a good introduction text on the subject will clear up a lot of your questions)
Japan used to enjoy creditor status, but with trade deficits like this that have to be funded (if it continues), they'll be our bosom buddies soon enough.
Ok, let me say it a different way, perhaps I'm not being clear with where I'm going. On a 10 year note, when does the cash enter the money supply and when does it come out? Agree, back in the "old normal". With our debt now, there's no way we can afford for rates to go up, and unless we get on a sustainable debt reducing track (fat chance there) we'll never be able to tolerate higher interest payments. Ever. Ergo, don't expect the expansion of the Fed's sheet to take place. It will continue to expand. Perhaps even "exponentially". When the Fed gets out of the US debt market, bond holders are going to demand much, much higher rates for the risk their taking on. I don't have a lot of questions, and I never wanted to talk about it in the first place However, I would like to personally thank you for engaging in a stimulating conversation without personal attacks. I tip my hat to you, sir, even if you are a Fed Apologist
When the Fed buys a 10Y note for its SOMA, it will pay the dealer cash. So, cash is released into the dealer's account. When the 10Y note matures, the Fed as the holder of that note, is entitled to the notional value of the note. That amount is then paid from the money supply(*) to the Fed. (*) Well, the treasury pays the notional. But the treasury pays it from the G part of GDP via tax or expenditure cuts (ha!) and not the magical fed balance sheet, so it's the same as money out of the money supply. This, by the way, if why the Fed reinvest the pay downs and interest from SOMA... otherwise, it's effectively shrinking the money supply. To be clear: no change in the SOMA account leads to a shrinking money supply Yes.... what's the problem? Yield will go up... 2%, 3%, 4%, etc... as it should. This is how it's suppose to work, no? The Fed exits when the economy rebounds, and rate will move in the expansion cycle of the economy. Thank you, I'm only engaging because I don't think you are an ET loon. Hey now.... I thought we are being civil. For the record, I'm not sure what the Fed is doing will work; If it does, it will validate Bernanke's life work on how to deal with a depression. If it doesn't.... well, I hope it does. But that being said, I do think the VAST majority of popular critique of the Fed is based on complete ignorance of how the Fed works.
The Fed apologist comment was a joke, hence the smiley following it. As for the 10y note, the cash goes into the dealer account right away, and it is this increase in the money supply that would combat any near term attempt at hiking rates (not that I believe that will ever happen, which brings me to my next response)... Agree, this is how it's supposed to work. I just don't see how the Fed can ever let yields go up knowing that when we do, we won't be able to afford it.
Okay, maybe this is the part that's not connecting: the fed will WANT rates to go up when the economy is in solid expansion. The Fed will keep the rates down until that happens. We can't afford it? Why the hell not? We can easily afford a 4-5x increase in interest payment (not to mention higher revenue when we are in expansion mode). And I'm unwilling to bet that the US can't roll its debt as it gets into expansion. This aint' going to be greece - we got land and aircraft carriers.
I'm totally confused by this... SOMA is part of the monetary policy. So is hiking rates.... why would one need to combat the other? Further, again, no more purchase in SOMA is actually contractionary. So, no SOMA purchase + hiking rates will work in the same direction.