Friday, January 23, 2009

Fed Stands Ready To Monetize Deficit

Interesting post at the Real Time Economics blog at the Wall Street Journal, noting that Treasury yields have risen somewhat in recent weeks, something which is [probably correctly] attributed to the rapid increase in the supply of Treasuries used to finance the enormous budget deficit.

While yields remain very low by historical standards, the Fed still wants them lower in order to push down other interest rates, the idea being that given a certain level of risk aversion, lower Treasury yields will lower other interest rates as well, and vice versa.

Since the deficit, and so the supply of Treasuries, will only get bigger during the new Obama administration, lower Treasury yields will require higher demand. To achieve that objective, the Fed could of course lower inflation expectations or increase risk premiums, but that would conflict with the reason they had in the first place for wanting to lower Treasury yields. That leaves them essentially with the option of monetizing the debt, by directly or indirectly buying Treasuries.

It's either that or the Fed accepting what chairman Bernanke thinks is the greatest possible evil: deflation. I see little reason to doubt that Bernanke will choose inflation over deflation, meaning that monetary inflation will likely get worse.


Anonymous Anonymous said...

Several wrote about this back in the 80's. Either government will raise taxes (not popular), cut spending (fat chance), or monetize the debt (quite convenient when you own the printing presses!) to cover its wild spending habits. And they have finally decided to monetize the debt. I for one saw it coming.

11:53 AM  
Anonymous Anonymous said...

It is clear who is buying the Treasuries buy is there anywhere we can see if someone else than the Government is selling?

There is no doubt in my mind that the FED and Washington want a weaker dollar.

What is the probability that China dumps some of its huge reserve under an agreement with the U.S that China will let the yuan appreciate in a more rapid rate or even cut the peg totally?

7:45 PM  

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