The Federal Reserve Was Quiet In Q1, But Stands Ready To Do More

by: John M. Mason

In the first quarter of 2012, the Federal Reserve was very quiet. The reserve balances that commercial banks held at the Fed actually declined by about $4.0 billion during the quarter to total $1.563 trillion on March 28.

Securities held by the central bank declined by slightly more than $15.0 billion as the Fed’s portfolio of Treasury securities, Federal Agency securities, and mortgage-backed securities all fell during the period. Over the last four weeks of the quarter, very little took place in the Fed’s holdings although, in aggregate, there was a small decline.

The factors supplying reserve funds to the banking system actually declined by about $48.0 billion but this was offset by around $44.0 billion in factors absorbing reserve funds.

The biggest item impacting the decline in reserve funds being supplied was the reduction in Central Bank liquidity swaps that occurred as the financial crisis in Europe resided and most of this took place in the last four weeks of the quarter. This was offset on the liability side of the Fed’s balance sheet by a number of operational factors, none overly significant.

These data just reconfirm the signals that Chairman Bernanke has given Congress, financial markets, and the academic world about the current stance of monetary policy. The Federal Reserve is not doing a lot right now, but will not back off from the quantity of reserves it has injected into the banking system over the past two years, and stands ready to do more if the need should arise.

And, short-term interest rates continue to remain exceptionally low. Since the Fed is doing little or nothing to supply more reserves to the banking system, the fact that the short-term interest rates are staying so low implies a lack of strength in the demand side of the market. This, I believe, is an important thing to keep our eyes on because if the demand for funds begins to pick up, this will put pressure on short-term interest rates and the Fed will either have to step in to prevent this rise because of economic or banking reasons, or, let the rates begin to increase. This is an area to watch.

This all sounds pretty dull, but…the central bank really likes things dull!

For one, only 16 banks were closed by the FDIC in the first quarter of 2012, compared with 18 banks being closed in the last quarter of 2011. We will have to wait for over a month and a half before we know how many more banks left the banking system through mergers and acquisitions. Last year, the banking system lost, on average, 60 banks per quarter and only 23 of these were banks that were closed by the FDIC. The number of commercial banks in the banking system continues to decline, but in an orderly and calm fashion. Dull is good!

Economic growth continues, but it is not exceptional. (For more on this see my recent post .) There is not too much more that the Fed can do in terms of stimulating more rapid economic growth, but it does hope to contribute to a turn-around in the housing area.

But, the economy is growing, and, barring shocks related to gas prices, a collapse of the eurozone, or an economic slowdown in China, among other things, it should continue to grow over the next several years, although the expansion will not be robust.

This is not all bad since many households and businesses are still reducing debt loads and trying to get their finances in order.

The problem is in the employment area. It is not just that the unemployment rate continues to stay too high, it is that under-employment still hovers around 20 percent. A reason the unemployment rate might not drop too much over the next six to twelve months is that if the job market becomes more active, people who are now not considered to be a part of the labor force will re-join the labor force hence helping to keep unemployment rate higher than desired.

One thing is apparent and that is the Fed does not seem to be doing anything dramatic about getting the unemployment rate done more rapidly in advance of the Presidential election in the fall. Given the lag-in-effect of monetary policy, the Fed has done just about all it can to achieve lower unemployment numbers this summer and fall.

This may be one reason why we are not seeing the announcement of another round of quantitative easing. The current Fed has already been accused of being one of the most “political” central bank administrations ever. Announcing another round of quantitative easy at this time would only exacerbate those cries. And, in my mind, would be able to achieve little or nothing in terms of a more vibrant economy and labor market through the end of the year.

Thus, I believe the Fed will remain relatively benign over the course of 2012. Again, dull is good when it comes to central banking. But, this doesn’t mean that the central bank will not act during the year if there is a real need for action, coming from the banking sector, the economy, Europe, or elsewhere.