The Fed today opted to keep its zero interest rate policy on short rates and to expand its
balance sheet by $600 bil. or 26% through mid-2011. Assuming that private sector credit
demand remains flat or in slight decline, this $600 bil. infusion via Treas. purchases would
allow my broad measure of financial liquidity to expand by up to 5% through mid-2011.
This represents adequate liquidity to fund the economic recovery well into next year and
puts and end to a risky liquidity freeze imposed by the Fed in early 2010. As I have
discussed several times, the Fed underestimated how cautious the private sector would
be during this recovery and finally had to scramble up a plan when it became clear that
the economy was not strong enough to engage private sector borrowing to maintain
economic growth.
The size of the package is in my view overstated because the Fed had allowed nearly $200
bil. to drain from the adjusted monetary base before finally taking action, but it is large
enough to provide strong liquidity back-up to the economy going forward.
I think the Fed will halt this program when private sector credit demand begins to firm
up and show some vitality. For now, it is unclear when that will happen.
It is also important to recognize that although this new round of money printing may be
a necessary condition to have continued economic recovery, it may well not be a
sufficient condition of same, since even deeper private sector caution and fear
could still undermine it. But, and thankfully, this new round of liquidity infusion will
give the economy a fighting chance.
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