anders Posted October 1, 2014 Share Posted October 1, 2014 Hi guys, Im trying to get me head around this topic and would very much appreciate your help, as I understand it - in short - FED has lost its power to control the rates. As they no longer have any means to enforce the policy, they can only attempt to guide where they would like the interest rates to be in future. So even if they can move the funds target rate higher, their tools to enforce the decision is very limited. So if I understand this correctly, if they want to return to a Fed funds target, they need to drain the trillions of excess liquidity that they have provided to the banking system. To reduce the excess liquidity they could: a) sell Treasuries / MBS (prob not going to happen since it would drive up short term rates above 3% so the fed becomes CF negative) b) stop reinvesting maturing bonds (but the big maturities start at 2018 due to operation twist) c) Make a deal with Treasury to swap long term holdings to short term (would probably shock the market and sink the credibility of USA) d) Reverse repo (They can attempt to guide rates higher by increasing the repo rate. But yesterday when the FED made the repo, not only did it go above the 300 bn cap, the lowest rate of the auction was -0,2%, hence the repo was not effective and future repos will probably look the same). And from here Im lost :-\ What are the FED going to do and how can they do it? If they cant reduce the excess liquidity relatively quickly, they will probably lose ability to respond to potential inflation. Link to comment Share on other sites More sharing options...
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