A new debate is set to rage within the Fed in the wake of its decision to re-open currency swap lines with foreign central banks.
Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, today said at an event in North Carolina that the move was “not a problem” but “we’re going to think about whether we sterilise” the swaps.
In English, this means offsetting the expected increase in the Fed’s balance sheet caused by the swaps with other measures, even though the volume of swap activity is not expected to be anywhere nearly as large as the near $600bn level it hit during the financial crisis.
In a research note on Monday night, Ed McKelvey, the Goldman Sachs economist, nicely laid out three tools the Fed could use for “sterilisation”.
The first and easiest, he claims, would be to boost the Supplementary Financing Program (SFP) beyond its current level of $200bn. The SFP allows the Treasury to sell debt and store proceeds at the US central bank, thereby removing liquidity from the financial system. But Mr McKelvey warns that this could lead to accusations that the Fed is not independent enough from the administration.
The second tool would be to transform the testing of term deposits and reverse repos into sterilisation operations. The Fed would therefore ramp up these tests slightly more than it was originally planning, I assume, and hope that they work properly.
The third and final tool is for the Fed to start selling mortgage assets earlier than planned, which is something that Mr Lacker and other hawkish central bank officials have pressing for.
