The recent set-back in markets may partly reflect worries about a withdrawal of liquidity support by the Federal Reserve and other central banks. Such concerns are premature: the US monetary base is likely to reach a new high this spring.
The Fed plans to complete its purchases of about $1.425 trillion of agency debt and mortgage-backed securities by the end of March. As of last week, its balance sheet contained $1.135 trillion of such securities, implying $290 billion yet to be added.
Payment for this $290 billion will be made by crediting banks' reserve accounts at the Fed, which – together with currency – constitute the monetary base. Other things being equal, therefore, the base will rise from its current level of $2.037 trillion to $2.327 – a 14% increase.
The Fed, however, is simultaneously closing several liquidity support operations, including the term auction facility, the commercial paper funding facility and swap arrangements with other central banks. Lending under these facilities totalled $47 billion last week. In addition, banks may choose to repay the $16 billion of discount window loans still outstanding.
The $290 billion addition to the monetary base from securities purchases, therefore, will be offset by a repayment of up to $63 billion of emergency support, suggesting a net increase of $227 billion or 11% – see table.
The Fed, in theory, could sterilise this injection, by selling Treasury securities or running down "other" assets, asking the Treasury to hold more cash in its account, or conducting reverse repurchase agreements (included in "other" liabilities). Officials, however, are likely to view a further expansion of the monetary base as desirable given ongoing worries about the sustainability of the revival in the economy and markets.
