Diane Swonk, Chief Economist
August 10, 2010 – 1:45 p.m. CT
Fed Keeps Balance Sheet Stable
The Federal Open Market Committee (FOMC) downgraded its outlook for economic growth, and decided to hold interest rates within the 0 to 0.25% range. In a surprise move, however, the committee decided to offset any declines in the size of its balance sheet due to the maturing of mortgage-backed securities (MBS) portfolio with additional treasury bond purchases. This will help to keep monetary policy easy even if inflation further decelerates, which is likely.
Tom Hoenig – president of the Kansas City Fed and host to the widely-watched Jackson Hole, Wyoming Fed conference – once again voted to dissent on the use of the "extended period" language. He represents a minority of Fed presidents who fear that the Fed may be sowing the seeds of future imbalances by being so explicit about how long they will hold rates at essentially zero.
That said, the majority of the Fed is clearly moving closer to another quantitative easing of monetary policy, or further expansion of the Fed's balance sheet this fall. At that time, the Fed is likely to buy MBS instead of treasury bonds, as that would provide a lift for the moribund housing market. (Many cite ongoing weakness in housing as a primary reason for the duration and depth of the Great Depression.)
Will it make any difference? We are still in unchartered waters, and those who oppose additional easing fear that the Fed could do more damage than good to the economy over the long haul if it eases further. They cite the role that monetary policy played in fueling the housing market bubble early in the decade. There is a growing sense among members of the FOMC, however, who would rather have tried to stimulate more and failed than not to have tried at all.
Finally, there is the issue of staffing on the Fed's Board of Governors. Congress has done a very poor job of approving governors for the Fed's Board in recent years. Last week, Senator Richard Shelby (R) of Alabama, who has held up multiple nominations to get more pork-barrel spending for his constituents, blocked Obama's nomination of Peter Diamond for Federal Reserve governor. I do not know Dr. Diamond, but I do know of him, and I am disgusted that such a qualified candidate would be discarded because of partisan bickering. Both Democrats and Republicans have been guilty on this front, and its time to put an end to it.
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