Piggy Bank Watch
By Arnold Kling
Where did the Fed obtain the funds to make all these loans and later buy all this MBS? Mechanically, the Fed implements any of these operations simply by crediting new deposits to the account that the receiving party maintains with the Federal Reserve. You can think of those accounts as electronic credits that the bank could ask at any time to redeem in the form of green currency delivered in armored cars by the Fed to the bank. Because the Fed had no desire to deliver this quantity of currency, up until the fall of 2008 it essentially sterilized the new loans by selling off some of its holdings of Treasuries.
…If the purpose of holding the MBS is indeed to produce a monetary stimulus, and if the purpose of raising the interest rate paid on reserves is indeed to produce a monetary contraction, why would the Fed want to do both at the same time? And yet Bernanke made pretty clear that he has no plans to sell off the MBS, which would be the logical way to contract. Instead it sounds like the Fed basically intends to hold those MBS to maturity:
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.