How does Fed add liquidity?
I have read a few times now that the Fed has provided a lot of cash in return for (on a temporary basis via repos) questionable assets. At the same time, they want to keep the money supply about the same to have Fed Funds remain where it is, and they do that by removing liquidity by selling their previously big Treasury holdings.
Net result is they have exchanged their Treasurys for bad assets and liquidity seems to me at least to be the same. If their goal is a) give banks more liquidity, and b) keep money supply the same to keep fed funds effective rate the same, how is that possible?
Thank you in advance, as always =]
they add liquitiy numerous ways. They directly do it by selling dollars to banks, increase the supply of money, lowering the rate banks each other.
by buying bad credit they do it indirectly.
Not sure that fully addresses my question..
to lower rates they buy govt bonds back through open market operations. the buying of bonds pushes the prices up and the yield down (hence the lowered rates). they set a target rate (like they will do tomorrow, wednesday) and then they buy and sell in the market until the price fluctuations make a certain rate hold steady. then they conduct open market operations to maintain that rate. this buying also puts cash into the economy.
thats typically how its done... now... who knows... they just drop money out of airplanes now i think....
My question isn't so much about how the basic operations work. It's that the Fed has been 1) providing liquidity by buying securities or other crap under the many new facilities, and 2) selling Treasurys and reducing money supply. 1 combined with 2 means that net money supply is actually the same, although all of the media has been saying that banks have more liquidity? I understand that Treasurys are not necessarily sold to banks, but the money will flow through and ultimately come from banks' holdings, so (2) definitely removes liquidity.
Of course, this changes a bit now that the Fed Funds rate has been lowered. More money supply has been theoretically added to get to that point. But before today's happening, how is it that the Fed has been providing liquidity if it has been removing the same amount of liquidity in order to keep money supply, and thus, Fed Funds rate, the same?
The fed hasn't been sterilizing capital injections fully so 2 hasn't been happening (the fed has a fairly large balance sheet and has been absorbing these securities on its balance sheet). Also, as others are pointing out, in this case the fed is trying to increase liquidity for the banks... if this is succesful, the money multiplier will increase and the results for the economy's liquidity are obvious.
One of the wonders of economics is how/if/why sterilized intervention has any effects.
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