Looking at the Fed’s Exit Strategy

Since the financial crisis began, the Federal Reserve has exploded its balance sheet from less than $1 trillion to over $2.2 trillion. Last week, Ben Bernanke discussed the Fed’s exit strategy. James Hamilton has an interesting take on what the Fed plans. Essentially, all of the strategies boil down to one thing—borrowing from the public.
As Arnold Kling has noted, the Fed is doing something very different here. It’s moving away from its basic function of being a central bank:

The Fed should be engaging in ordinary open market operations, which means buying Treasuries. The only reason to buy anything other than Treasuries would be if it ran out of Treasuries to buy and still could not meet its overall target–whether that target is for the money supply, nominal GDP, or some weighted average of inflation and unemployment.
When the Fed instead is selling Treasuries or paying interest on reserves in order to sterilize the effect of buying other stuff, it is not being a central bank. It is being a piggy bank.

Posted by Eddy Elfenbein on February 15th, 2010 at 9:49 am

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.