Tuesday December 16, 2008 - 21:26:20 GMT
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Larry Greenberg - currencythoughts.com
FOMC Embraces Quantitative Policy Approach: Lessons from Japan and Implications for Dollar
By unanimous vote the Fed reduced the Fed Funds target to a range of zero to 0.25% from a point target of 1.0%. Much more importantly, officials â€świll employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability.â€ť In the present context, â€śprice stabilityâ€ť refers to avoiding deflation, not promoting disinflation. The statement specifically announces that Fed purchases of agency debt and mortgage-backed securities will be â€śexpanded,â€ť that consideration is being given to buying longer-dated Treasuries, and that other expansions of the Fedâ€™s balance sheet are being explored to support economic growth and credit market functionality.
The missing ingredient is the lack of quantitative growth rates for the balance sheet, money aggregates, credit, or excess reserves. Otherwise, this policy shift is a mirror image of what was announced in October 1979 to reduce double-digit inflation. For five years until March 2006, the Bank of Japan engaged in quantitative easing, keeping overnight rates pinned at zero and progressively raising a target for excess reserves. Japanese consumer price inflation excluding energy and food was still somewhat negative when that policy reverted to targeting interest rates. Some critics argued then that the shift was made too soon, and sure enough, Japan is now headed back into deflation.
But Japanâ€™s experience underscores a danger. Nominal interest rates kept at zero or quasi-zero levels seem to change money market functionality in enduring ways and damage an economyâ€™s tolerance for what used to pass for normal interest rate levels that lie well above zero in both nominal and inflation-adjusted terms. Bank of Japan officials repeatedly revealed long-range plans to lift interest rates but never found an opportunity to act out that intention, even though Japanâ€™s economy experienced its longest postwar economic expansion with real GDP growth that averaged 2.1% per annum over 6-1/4 years. See more on www.currencythoughts.com
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