The Federal Open Market Committee held its regularly scheduled meeting today, amidst of a number of alarming economic developments. The committee voted to maintain its current policies, with a hint at further easing if conditions continue to get worse. The most aggressive decision the FOMC made was to state that it plans to keep short-term interest rates at zero through mid-2013 at the latest, reassuring markets that it won’t tighten monetary policy anytime soon, even if it’s not doing anything else (such as a QE3) to loosen it.
One aspect of the FOMC annoucement that would be easy to overlook is the Fed’s commitment to maintaining the current size of its balance sheet. In the release, the committee writes that it will “maintain its existing policy of reinvesting principal payments from its securities holdings.” What that means, in effect, is that it will continue to bring the effects of QE2 to bear on the economy.
The much-debated QE2 was, in effect, an second significant expansion of the Fed’s balance sheet through the purchases of Treasury securities. In the graph of the Fed’s assets below (taken from the Cleveland Fed), it is easy to see to make out two discrete expansions of the Fed’s holdings: one in the fall of 2008 (QE1), when the Fed purchased over $1 trillion of assets to stabilize financial markets, and another beginning more gradually in the fall of last year (QE2), consisting of the Fed buying roughly $600 billion in Treasuries (represented by the yellow area).
By promising to reinvest principle payments on the securities it owns, the Fed is basically pledging that its total holdings will remain at the elevated, post-QE2 level.
Although the Fed stopped purchasing extra government bonds as part of QE2 in June, they haven’t sold any off since. Owning the bonds has a similar stimulative effect to buying them.
In other words, the Fed’s announcement today means that it will continue to be at least as accomodative on monetary policy as it has in the past half-year, and possibly even more stimulative. QE2 hasn’t ended, it’s been extended indefinitely.
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