That’s the five word summary of John B. Taylor’s commentary on Fed actions:
The Fed has effectively replaced large segments of the market with itself—it bought 77% of new federal debt in 2011. By doing so, it creates great uncertainty about the impact of its actions on inflation, the dollar and the economy. The very existence of quantitative easing as a policy tool creates uncertainty and volatility, as traders speculate on whether and when the Fed is going to intervene again. It’s bad for the U.S. stock market, which is supposed to reflect the earnings of corporations.
I’m all for more predictability with the Fed. It is a little ridiculous to steer policy on data that’s months old.
There are basically three reasons for the Fed to acquire so many bonds: to keep reserve balances high and keep the FF rate at zero, to increase the money supply by increasing size of the monetary base, to indirectly fund Treasury Department purchases.
Acquiring Treasurys to maintain the target interrst rate isn’t even necessary any more since the Fed now pays a support rate on excess reserves.
The money supply does not respond to the monetary base. The relationship is actually inverse, though the Fed still behaves as though it hasn’t realized this.
Funding Treasury expenditures by buying bonds on the secondary market is the only legitimate reason left, but this is a self-imposed constraint to stop the central bank from directly funding spending. We could do away with Treasurys at any time and just issue a national CD if we wanted to make sure the non-government sector had a risk free savings vehicle.