Financial markets respond to each Fed statement related to its strategy of buying $85 billion a month in securities.
Stock prices fell sharply when Bernanke indicated the Fed was likely to reduce the pace of such buying.
Bernanke then came back and said the pace of the buying would not affect the Fed’s target of zero short-term interest rates.
The logical question is why does the Fed have a strategy of purchasing $85 billion a month, if it isn’t related to the level of interest rates?
There are reasons, but none make any sense.
The most important reason is the Fed members have no idea what they are doing.
A second reason, related to the first, involves the Fed’s use of the Keynesian framework.
In Keynesian economics, confidence and sentiment play an important, even dominant, role. Hence, the Fed often announces policies — such as QE1, QE2 or QE whatever — in an attempt to alter consumer or investor confidence. It does so even though the direct impact on markets and the economy may be destructive.
In this regard, it’s informative to know that since last September, when the Fed first announced plans to purchase $85 billion a month in securities, bank reserves have increased by $541 billion or $60.1 billion a month.
Also during this period, banks increased their excess reserves with the Fed by $537 billion or $59.7 billion a month. Excess reserves are held at the Fed and are not available to boost bank loans and investments.
This means the increase in the amount of reserves available for boosting bank loans and investment has increased by less than $4 billion from September to June.
This is less than $.5 billion a month.
Since the monthly data are so erratic, the current pattern is subject to change at any time.
The main point here is to show how the Fed’s $85 billion a month in purchases appears totally unrelated to any logical approach to monetary policy. Hence, talk of tapering such purchases is equally illogical.
The latest data on bank reserves show an erratic monthly pattern for funds available for bank loans and investment. The annual growth in these reserves since September has been only a 3.5% annual rate. This is close to the 3.2% annual rate increase in bank loans and investments over the same period.
If you find all of this confusing, you are not alone.
The minutes of the Fed’s last meeting show you have a lot of company.