Where no Fed has gone before

The Fed has decided to change policy, no longer setting the federal funds rate and letting banks determine how many bank reserves they want, but directly targeting bank reserves, and in a massive fashion.

But to the surprise of investors and analysts, the committee said it had decided to purchase an additional $750 billion worth of government-guaranteed mortgage-backed securities on top of the $500 billion that the Fed is already in the process of buying.

In addition, the Fed said it would buy up to $300 billion worth of longer-term Treasury securities over the next six months. That would tend to push down longer-term interest rates on all types of loans.

Here is the statement from the FOMC:

In light of increasing economic slack here and abroad, the Committee expects that inflation will remain subdued. Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.

In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion. Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months. The Federal Reserve has launched the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses and anticipates that the range of eligible collateral for this facility is likely to be expanded to include other financial assets. The Committee will continue to carefully monitor the size and composition of the Federal Reserve's balance sheet in light of evolving financial and economic developments.

Here is a take by Scott Sumner, an economist who is actively following monetary policy (as opposed to someone like me, who currently finds a number of other topics more interesting, though not necessarily more important.)

This graph shows the M1-data until March 2

Here is a chart of excess reserves. Banks now earn interest on excess reserves, and cannot get more by trading them for T-bills, so they do not have the normal urge to get rid of them.

The Fed is not worried about inflation--it does not see that as a threat given the large amount of idle resources. However, because the Fed is increasing reserves even more, there will be a major inflation when the economy starts rebounding (because then those excess reserves will be traded for more profitable assets, spurring monetary growth) unless the Fed can take these reserves out of the banking system quickly enough and at the right time. How much faith do you have in the Fed? If you do not have a lot, then soon you should start betting on inflation in the future.
Update: China is worried about the future value of the dollar. It apparently is moving out of longer-term U.S. securities in favor of short-term.