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Monetary policy: Bernanke needs new weapons

Are we already into the era of unconventional monetary policy?

The Federal Reserve has not made explicit its embrace of quantitative easing or said that it is abandoning the nominal federal funds rate as its main policy instrument. But it is injecting huge volumes of extremely low-cost, short-term cash into the banking system. While the official federal funds rate stood at 1% last month, the actual rate at which banks received overnight federal funds was closer to 0.3%, as the Fed’s balance sheet ballooned from $800 billion in late September to more than $2.4 trillion in November.

So, even as private sector US growth estimates grew ever more pessimistic last month, and expectations mounted that the Fed would cut official rates by another 50 basis points this month and that nominal rates could be zero early next year, market participants might soon have to accept that the official federal funds rate is an irrelevance.

It is already for corporate borrowers and consumers. Credit spreads have risen, even as nominal rates have fallen, leaving the cost of borrowing high and the high hurdle rate from any debt-funded capital investment or asset purchase deterring borrowing and spending. Worse, this is only a consideration at all where credit is available at any price.

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