Adding to the stimulus

The Economist
November 28, 2008

THE Federal Reserve’s interest-rate target is near zero. The recession is deepening. No wonder that speculation is mounting about when America’s economic policymakers will start using truly unconventional measures to stimulate the economy.

• A d v e r t i s e m e n t

The answer is that they already have. Since early September, without any formal declaration, the Fed has radically expanded its balance sheet to counter the credit crunch. Under the guise of successive new programmes, each with a less memorable acronym than the last, the Fed is substituting its balance sheet with that of the contracting private financial system in the hope of keeping the economy from being starved of credit.

The current credit crisis is not a temporary shock like the September 11th 2001 terrorist attacks, which briefly severed the financial system’s internal plumbing. Rather, a radical reassessment of what constitutes acceptable levels of capital, leverage and interest rates is underway. Those financial institutions that have not failed are intent on reducing leverage—their volume of loans for each dollar of capital. The Fed has no hope of stopping this process; it is merely trying to slow it down by providing a home for the assets that the financial sector is shedding. The alternative is plunging asset values, a complete withdrawal of credit and economic catastrophe.

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