FOMC Was Told in December 2008 QE Needed to Be Very Large

Federal Reserve officials were told in December 2008 that they would have to buy “very large” quantities of U.S. Treasury and housing-agency debt to have an impact on the economy as they considered alternatives to cutting interest rates that were heading toward zero.

“The evidence suggests that this policy tool could have the desired effects, but that the scale of the purchases would have to be very large,” a team of Fed staff economists said in a Dec. 5, 2008, memo to the Federal Open Market Committee. The panel met 10 days later.

Staff estimated that a purchase of $50 billion of longer-term Treasury securities, or about 1 percent of all marketable Treasury debt held by the public, would lower the yield on 10-year notes “somewhere between 2 and 10 basis points,” according to a collection of memos released today.

The documents also warned that asset purchases might lead to capital losses as the economy recovered and interest rates rose, and that “some unconventional tools blur the line between providing liquidity and allocating credit.”

The more than five-year-old memos were obtained under a Freedom of Information Act request by Joseph Gagnon, a senior fellow at the Peterson Institute for International Economics, who was among the papers’ co-authors as a Fed board economist at the time. They show Fed officials preparing to take unprecedented steps at the Dec. 15-16 meeting were armed with myriad potential costs and benefits of the policy that became known as quantitative easing.

Balance Sheet

At the meeting, Fed officials cut the benchmark lending rate to a range of zero to 0.25 percent -- where it has stayed - - and announced that they were switching to a policy focused on the size of the balance sheet.

The economy was in its 13th month of the deepest recession since the Great Depression. The unemployment rate had climbed in November to 6.8 percent from 6.5 percent a month earlier, according to revised figures. Joblessness would reach a peak of 10 percent in October 2009.

Inflation as measured by the Fed’s preferred gauge, the personal consumption expenditures price index, had plunged to a 2.9 percent year-over-year pace that October from 3.7 percent a month earlier. Prices would continue their descent, bottoming out at a minus 1.2 percent rate in July 2009.

Today, unemployment lingers at 6.7 percent while prices are rising at a year-over-year pace of 0.9 percent, less than half the Fed’s 2 percent target.

Grim Outlook

In a summary of the 21-chapter report, Brian Madigan, then head of the Fed board’s Division of Monetary Affairs, told officials that the outlook was grim and called for unconventional action because of the inability to lower the short-term policy rate below zero.

Based on models, Madigan and two other staff economists reported that the federal funds rate would have to go as low as minus 3 percent to provide enough stimulus.

“Our inability to make the funds rate negative means higher-than-desired unemployment and lower-than-desired inflation for several years,” the economists warned. Board models and forecasts “suggest a sizable probability of a deep and prolonged economic slump that could result in deflation.”

Then-Chairman Ben S. Bernanke, in an unusual step taken outside of an FOMC meeting, ordered the New York Fed to buy $100 billion of debt issued by housing agencies and up to $500 billion in mortgage-backed securities in November 2008.

The committee recognized that decision at its December meeting. In March 2009, it launched its first major round of quantitative easing, announcing $750 billion of additional mortgage-backed securities purchases for a total of $1.25 trillion, and purchases of $300 billion of longer-term Treasuries, and a total of $200 billion in agency debt.

The Fed is still in the midst of its third round of QE, which has pushed the balance sheet to a record $4.23 trillion. Policy makers are winding down the program, with the monthly pace of purchases reduced to $55 billion at the March meeting from $85 billion in December.

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