A Focus on Quantitative Easing
In an unprecedented move at its December 16 meeting, the Federal Open Market Committee (FOMC) decided to establish a target range for the federal funds rate of 0 to ¼ percent. The Board of Governors also reduced the primary credit rate to ½ percent.
Recognizing that interest rate policy reductions had essentially reached a zero bound, the Committee stressed that the “Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability.” Further, the Committee stated that the focus of “policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve’s balance sheet at a high level.”
Open market operations and other measures have added greatly to the supply of the monetary base, which jumped from around $850 billion in late August to nearly $1.7 trillion on December 31. The doubling of the monetary base in such a short time highlights the fact that the Federal Reserve had already employed other available tools in dramatic fashion to support the functioning of financial markets.
It is apparent from the explosion of the excess-reserves component that the surge in total bank reserves has not been associated with a commensurate surge in bank loans. Rather than lending the additional reserves, many banks have held on to them in an effort to improve their balance sheets.
The additional reserves have been associated with some positive signs for liquidity. A key indicator of liquidity is the spread between the London Interbank Borrowing Rate (Libor) on a term loan and the interest rate paid on an Overnight Index Swap (OIS) for a comparable maturity. The Libor–OIS spreads on both one-month and three-month maturities jumped to record levels in September, but have receded substantially as the monetary base has expanded.