Fed takes third step in exit strategy

With the announcement Wednesday that the US Treasury will be reviving the Supplementary Financing Program, the Federal Reserve made its third move in exiting emergency recovery measures. 

By , Guest blogger

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    Lao Tzu, the Chinese philosopher and father of Taoism, is depicted in this detail from 6th century BC artwork.
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As Confucius Lao Tzu once said, a journey of a thousand miles begins with a single step. The Fed faces just such a journey today: returning monetary policy to normal as the economy heals. And in case you didn’t notice, the Fed has already taken three steps down the road.

Step 1 was the termination of various special credit facilities (e.g., the Term Auction Facility) that were created to provide liquidity during the crisis.

Step 2 was last week’s sort-of-surprise announcement that the Fed was increasing the discount rate from 0.5% to 0.75%.

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Step 3 is today’s announcement that Treasury is reviving the Supplementary Financing Program (SFP). Over the next two months, Treasury will issue $200 billion in bills for the SFP and then place the proceeds in its account at the Fed. The SFP will thus mop up $200 billion of liquidity that Fed asset purchases have injected into the monetary system.

Treasury began the SFP in September 2008 when the Fed needed help sterilizing the monetary impact of the programs it created to provide liquidity to the financial sector. The program peaked at more than $500 billion in late 2008, and then began to decline as sterilization ceased to be a Fed concern and as the federal debt limit began to loom. With the recent increase of the debt limit, Treasury again has room for the SFP, hence today’s announcement.

Update: Thanks to Brooks for pointing to Lao Tzu as the source of the famous quote; many sites attribute it to Confucius, but those claiming Lao Tzu seem more credible. If you start Googling or Binging this topic, you can also explore such amusing issues as: How do you spell Lao Tzu? Didn’t he really say “a journey of a thousand miles begins beneath one’s feet”? And “wait a minute, the ancient Chinese didn’t use miles, did they?”

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