Wednesday, December 24, 2008

Federal Reserve's Liquidity Injections: A Revew

The time has come for big, bold monetary maneuvers. After completely exhausting the interest rate option,
the Federal Reserve is now turning on the taps full force by injecting massive amounts of liquidity directly into the economy.
The impact of this injection is already being reflected in the money supply, as the aggregates have ballooned by a breathtaking 20% or so at an annual rate.
In times of recession, and especially during a financial crisis, the monetary authority must increase the money supply in order to compensate for the slower velocity of money.
The Federal Reserve’s massive bailout of the financial system is starting to bear fruit. The task ahead remains daunting, but the first positive signs are being observed and liquidity is finally beginning to seep out.
All in all, we firmly believe that an economic recovery will come about in the United States and that opposite fears of rising inflation and corrosive deflation are overblown. This position is also supported by the price of gold.
Observers concerned about inflation make the case that the Fed will fail in its attempt come the time to drain some of the liquidity out of the economy once it is up and running again.
We are more optimistic in this regard. Inflationary pressures would take some time to surface, thus allowing the Federal Reserve to rein in its liquidity fast enough to prevent prices from racing out of control.
In fact, however difficult it may be to remember nowadays, the central banks know very well when and how to raise interest rates.

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