I hesitate to write this piece, because I think doing this would be a bad thing. Then again, I don’t believe that most of the jawboning done by the Fed is useful.
So let the Fed put its money where its mouth is, and, hey, improve its asset-liability match in the process. After all, over the last five years, the Fed discovered that they have an asset side of their balance sheet. They decide that they can try to twist the Treasury curve, lowering long rates, and stimulate the housing market via QE.
But aside from monetizing debt, which often leads to serious inflation, QE has not shown much potency to do anything good. Thus the Fed thinks that enhanced guidance will be the tool to use to breathe life into this over-leveraged economy. A possible example: “We promise not to raise the Fed funds rate until 2017.”
Deeds, not words, I say. I challenge the Fed to do the following: Offer multiple tenors (maturities) of Fed funds. At present, Fed Funds is an overnight rate. Offer 1, 3 and 6-month Fed funds. Offer 1, 2, 3, 5, and 10-year Fed funds. Give the banks the ability to lock in funds for lending or investing for longer amounts of time. Create the Fed funds yield curve.
Rather than merely promise that Fed funds will remain low for so many years, offer banks a way to have a guarantee of low Fed funds rates for that time period. That would be powerful. Whether it would be powerful for good is another matter. Personally, I doubt it would be good, and I think the same of enhanced guidance.
In doing this, the Fed might realize that they have a liability side of the balance sheet, and one that does not have a zero duration. If they have long term assets, why not long term liabilities?
Sigh. In the old days it was easy. The Fed did not have an over-leveraged economy, and so they invested in short-dated Treasuries, and adjusted Fed funds as their major policy lever. Open market operations took care of the rest.
Introducing long term liabilities to the Fed means that policy accommodation can no longer be removed instantly. The longer dated Fed funds would only shift as it matures. It would give strength to monetary policy in the short run, but weaken it in the long run. But hey, we are a short-run society, so why should we care? Bleed our grandchildren dry, and have the great-grandchildren ready to be bled for our good.
Eventually we have to question why we are pursuing policies that harm the long-run in order to goose the short-run. Once we start doing that, we might be on the road to maturity, even if it means we get a severe recession, or even a depression. The “greatest generation” was the greatest because of character formed out of depression and war. Sad that they sucked the blood of their grandchildren via Social Security and Medicare. We live with the results of their short-term thinking.
By David Merkel, CFA of Aleph Blog
