WSJ Hilsenrath – QE3 may be sterilised

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The WSJ’s Jon Hilsenrath has another of his ‘fly on the wall’ stories.

He says that there are three options on the Fed’s table:

• First, they could use the method they used aggressively from 2008 into 2011, in which the Fed effectively printed money and used it to purchase Treasury securities and mortgage debt. The Fed has already acquired more than $2.3 trillion of securities in several rounds of purchases using this approach, widely known as “quantitative easing,” or QE.

• Second, the Fed could reprise a program launched last year in which it is selling short-term Treasury securities and using the proceeds to buy long-term bonds. This $400 billion program, known as “Operation Twist,” allows the Fed to buy bonds without creating new money.

• Third, in the new novel approach, the Fed could print money to buy long-term bonds, but restrict how investors and banks use that money by employing new market tools they have designed to better manage cash sloshing around in the financial system. This is known as “sterilized” QE.

The Fed has really bought into the portfolio balance channel.

In my view, QE, if it works, works by shortening the duration of Government liabilities. Switching overnight to one month via repo doesn’t change much.

Here is how i see it.

The Fed replaces a 10yr bond (loan to the govt) with high powered money (an overnight loan to the govt), and then ties that up in a short term deposit that is secured by their vast asset portfolio.

Given that short term rates are basically zero, and that repo is vey liquid, i do not see how owning repo is any different from holding high powered money on deposit at the Fed.

The main thing to commend this approach is that it develops the Fed’s expertise in conducting LARGE scale repo – skills that will be required when they eventually seek tighten monetary conditions.

At the margin, it will also decrease concerns about QE driving a collateral squeeze, by suching up all the high quality paper (though if you are a portfolio balance thinker, surely you regard that as the point?).

News that the Fed is still talking about stimulus ought to be good for ‘risk’.


  1. Ricardo, thoughts on GDP/employment data re interest rates?

    For me the RBA will wait for the inflation data, but if data continues in this fashion then a cut becomes only a matter of when

    1. Hmm, i think the economy is a bit below trend, but really that is just because i think potential gdp is higher. The awful truth may be that it is lower, which is consistent with the recently steady unemloyment rate – i would say it has been steady at ~5.25% for 8 months.

      If the unemployment rate rises again in the march report and CPI is low, they will cut in May, but you sort of need two trumps from the random number generator, if you see what i mean.

      Sent from my iPad

    1. i think he gets to the right conclusion: ‘theres no meaningful difference between interest bearing ERs and these short term repos’

      [… but i don’t get some of his arguments]

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