The big news today on the economic calendar for this evening, following on from the CPI data released earlier today. Having already cut the target for the federal funds rate to a range of zero to 0.25%, there was no surprise at its end of January meeting that the Fed nominally maintained its policy stance. However, in the light of the deterioration in economic conditions since the December meeting it emphasised that the exceptionally low levels of the federal funds rate was likely to be warranted “for some time”. The statement noted that “conditions in some financial markets had improved”, in part reflecting efforts on the part of government to provide liquidity and strengthen financial institutions. But despite this, “credit conditions for households and small businesses remained extremely tight”. At the same time, inflationary pressures were likely to remain subdued, with the primary risk being that “inflation could persist for a time below rates that best foster economic growth and price stability in the longer term”. In other words the Fed is concerned about the risk of deflation.

To combat these downside risks to real economy and inflation the policy statement reiterated the Fed’s determination to “employ all available tools to promote the resumption of sustainable growth and to preserve price stability”. Central here was to “support the functioning of financial markets and stimulate the economy through open market operations”. To this end, the Fed is already engaged in purchasing large quantities of agency debt and mortgage backed securities to support the mortgage and housing markets, but thus far this has been funded by the sale of Treasury bills. As this does not directly lead to an increase in the monetary base, such action constitutes credit rather than quantitative easing. That said, the statement did indicate that the Fed was prepared to extend the programme to buying “longer-term Treasury securities”.

However, with the exception of Jeffrey Lacker, president of the Richmond Federal Reserve, no-one on the Committee as yet wanted to embark on such a policy funded by the creation of new central bank money. Given that apart from the anomaly of the Second World War there has never been a single instance where an increase in government spending (funded by increased borrowing) has succeeded in generating an economic recovery without an increase in the money supply, the sooner it embarks on full QE the better.

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