Fed Admits Another $4 Trillion In QE Will Be Needed To Offset An "Economic Shock"

Tyler Durden's picture

In a Fed Staff working paper released over the weekend titled "Gauging the Ability of the FOMC to Respond to Future Recessions" and penned by deputy director of the division of research and statistics at the Fed, the author concludes that "simulations of the FRB/US model of a severe recession suggest that large-scale asset purchases and forward guidance about the future path of the federal funds rate should be able to provide enough additional accommodation to fully compensate for a more limited [ability] to cut short-term interest rates in most, but probably not all, circumstances."

So far so good, however, there are some notable problems with the paper's assumptions, as Citi head of G10 FX, Steven Englander, observes.

He writes that the paper’s basic framework is to take the standard US economic model used by the Fed, give it a negative shock big enough to push the unemployment rate up by 5 percentage points (big but not unprecedented over the last 50 years) and deploying the Fed’s policy rate, QE and forward guidance tools to see if they are adequate to get the economy back on track. Negative rates and helicopter money are not used.

The two simulations assume:

  1. the economy is in equilibrium initially with inflation at 2%, r* at 1%, so equilibrium nominal fed funds is 3%
  2. the economy is in equilibrium initially with inflation at 2%, r* at zero (secular stagnation) and equilibrium nominal fed funds at 2%

He compares three policy approaches. The first assumes a linear world where fed funds can go into negative territory but there is no breakdown in the structure of economic relationships. It is probably not a realistic view of policy ineffectiveness at negative rates, but it is mean to be a baseline. The second just takes fed funds down to zero and keeps it there long enough for unemployment to return to baseline.

The third takes fed funds down to zero and augments it with additional USD2trn of QE and forward guidance. A variation on the third policy response function doubles the amount of QE in the second simulation.

In other words, the Fed is already factoring in a scenario in which a shock to the economy leads to additional QE of either $2 trillion, or in a worst case scenario, $4 trillion, effectively doubling the current size of the Fed's balance sheet.

He continues his critique of the Fed's argument as follows:

In the simulations. QE and forward guidance take 10yr yields down 225-300 bps depending on the starting point for fed funds and whether you do $2 trillion or $4 trillion for QE. But that is not going to work very well if by design fed funds and 10yr yields can’t go below zero. And if expected rates are already low then forward guidance does not have much room. Fed official will gave to keep a straight face while saying they we will keep rates at zero … forever.


What makes it work is that QE and committing to low rates for longer gets the long rate down quickly and this compensates for the inability to take short rates down as far as you would want. In the unconstrained model, the maximum drop in short rates is almost 9 percentage points, almost twice as much as in the constrained model, but the QE/forward guidance  lower takes (and keeps) long rates 75bps lower than when the Fed takes rates to zero and stops. When the Fed is starting from 3% fed funds, the combo can almost entirely offset the zero constraint, but only if the full $4 trillion QE is brought to bear. Starting from 2%, QE of $2 trillion is not enough to get long rates down far or fast enough to offset the shock.

All of which brings Englander to the following stunning conclusion:

I would have rewritten the conclusion as: "large-scale asset purchases and forward guidance about the future path of the federal funds rate have almost no ability to offset a shock in current circumstances, but down the road may be able to provide enough additional accommodation to fully compensate for a more limited [ability] to cut short-term interest rates in some, but not all and maybe even not most, circumstances." The italics and colors show my changes.

Just as troubling, Englander admits that the nuanced read of the Fed paper admits it is effectively powerless to withstand a sharp recession: "The key policy issues and what drives the paper’s conclusions and my variant is the starting point. Were we to have a recession today or a year (or even two years) from now, it is very unlikely that the Fed weapons have anywhere near the potency that the paper describes. The FOMC had an end-2018 median fed funds rate of 2.4% at the June meeting and my guess is that it is lower now. Markets don’t price in even 100bps in fed funds till the end of 2019 (taking Eurodollar rates and subtracting 40bs or so.) That said, a 5% shock to the unemployment rate is pretty extreme, if the Fed is not stepping on the brakes hard or world not falling apart for other reasons."

How much room does the Fed have? Very little:

In the simulation is looks as if it takes about 160-180bps of fed funds reductions (peak response) to offset an 1% UR shock, so right now they could offset maybe an 0.20% shock to the UR with the rates room that they have.

But most troubling of all, is just how critical starting conditions are for further easing; considering monetary conditions right now are unprecedented, it means the Fed has its work cut out for it:

The problem the paper outs in relief is that the effectiveness of rate cuts/QE/rate guidance goes up with the starting point of rates – so the combined policy tools are much more effective if the fed funds rate is 3% than if it is 2% and certainly a lot more than if it is 40bps. There is a good reason the paper does not examine the options for fighting recessions under current conditions. The drop in fed funds also takes 10 year yields down, and roughly 30-40bps in 10s for every 100 bps in fed funds,  so if you are starting with fed funds at 40bps and 10yr yields at 160bps, rates policy/QE/forward guidance are not going to do much. Short rates, long rates and rate expectations have nowhere to go, unless you bring negative rates into the discussion, which does not occur.

And, as noted above, not less than $4 trillion in QE would be enough to "get long rates down far or fast enough to offset the shock."

What are the implications for the Fed, and thus to the market, as a result of the paper? It depends on whetyher one is a hawk or a dove:

To the doves fast growth and higher inflation inoculates the Fed and the economy from policy ineffectiveness at the zero bound so it is a very dovish outcome. Insofar as having 2.5% or 3% inflation makes policy more effective in a downturn there is a case for loosening the target, or not admitting to loosen but reacting to an overshoot anyway.


Hawks may argue that there is a case for raising rates faster, not slower, but the argument has to be made carefully. Assume that the next recession comes in a year from a source not related to Fed policy – the EU falling apart or a major geopolitical event. If fed funds is at 100bps, for example, they may have a meeting or two to stimulate by taking policy rates down while laying the ground for the much bigger stimulus from fiscal or helicopter money that would  be needed. If fed funds are very low, investors, households and firms may lose confidence when they recognize that policy has nowhere to go. But this logic depends crucially on this confidence effect which may or may not exist. Hawks can at any point argue that the risks of the zero bound are overstated or that easy Fed policy makes the next recession more likely by making a financial crisis more likely at some point, but that is outside the scope of the paper.

Incidentally, all of the above is a long-winded way of saying the Fed hiked rates, only to be forced it will have to not only cut them, as Japan did 7 months after its ill-fated August 2000 rate hike as we cautioned last August...


... but that when the US economy slides into the next sharp recession, no less than $4 trillion in QE will be needed to stabilize the economy, bringing the Fed's total holdings of government bonds to well over 30%. And with that in mind, we look forward to what "upside rate hike surprises" Yellen has in store for the market this coming Friday, especially if the politically-tasked Bureau of Labor Services continues to surprise to the upside with fresh record numbers of minimum-wage restaurant workers and bartenders.

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Consuelo's picture

Let's not front-run anything, shall we...?

OpTwoMistic's picture

That is the end of the dollar.  Guy says forever or until no one excepts the dollar ( Oct 2016 )

Got PMs??

TeamDepends's picture

Man the Printer Battle Stations! All hands on deck! Mayday, mayday!

froze25's picture

So we will do exactly what Japan has been doing and expect a different result?

NidStyles's picture

Wiemar, here we come!!!


This time it will be $4 Trillion, next time it will be $20 Trillion.

FreezeThese's picture
FreezeThese (not verified) NidStyles Aug 22, 2016 2:43 PM

What's the end game?

knukles's picture

These people don't know what the fuck they're doing.

rejected's picture

Whatever gave you that idea knucks?

waterwitch's picture

Since most of that $4 trillion is digital, why hasn't some hacker group gotten into that digital printing press and put a big negative sign in front of that number?

UnschooledAustrianEconomist's picture

I bet both my balls that the world's best (and most expensive) hackers are sitting around that printing press.

Try something and you get a visit of the world's best (and most expensive) hitmen.

leanux's picture

The Fed stole $30 TRILLION in 2008 alone. https://goo.gl/2SIIh0

remain calm's picture

OUT OF ONE SIDE OF THEIR MOUTH:  We may need 4 TRILLION in additional QE, AND 

OUT THE OTHER SIDE OF THEIR MOUTH: We will raise interest rates SOON.


Manthong's picture

The good news is that money grows on trees around the Eccles Building…

..and it sprouts from the ground…

..and it rains from the permanent dark cloud overhead…

and it comes out the wazoo of everybody that works there…

so, what’s the problem ?????????


nightwish's picture

Here's one problem - I dont think that troll Yellen has a sufficiently long enough neck to fit in a guillotine properly. The blade may get lodged in the occipital area of her skull and spoil all the fun of a proper beheading.

Manthong's picture

oh gosh.. I think you might be right...

well, as an afficionado of fine woodworking and scary sharp metal blade sharpening...

sometimes you just have to go back  to the basics

a chopping block and a large sword with my treatment will work in a pinch...

it might get sloppy and take a few hacks,

but that is an aiming problen and as long as the job gets done, WTF?

TrumpXVI's picture

No worries, nightwish....happened all the time with actual guillotinings.  They even had a dedicated assistant executioner (called "The Photographer") to pull a person's head through the stocks (by the ears) in order for the blade to get enough of a bite.

No worries....

ThirteenthFloor's picture

+1. Sums it up nicely. FU FRB.

Infocat's picture

They are about to steal even more! Buy precious metals! http://www.truthjustice.net

The Management's picture

Almost possible - Effectively default. Imagine the economy as river system. Current river flows west to east. We are all little fish reliant on flow direction. The Fed melts the ice far up above us in the mysterious unknown mountains. In a balanced and sustainable water cycle we would be limited by evaporation generated clouds only...instead we have quantitative pissings from above and the current is getting stronger. Eventually it will wash away anyone near it not large enough to form their own watersheds (Microsoft / Michael Moore), hence the destruction of middle class. Only way to stop process ( only way) is to stop using dollar - which is obviously impossible. So yeah...BUFU! Buy Us Fuck You!

Manthong's picture

using your thought model.....

the problem is that the Fed and .gov stock the water with Piranha.

TrajanOptimus's picture

If they keep this up I'm going to use a short stack to buy that billion Euro house in France and turn the 35 acre gardens into a Moslem housing project.

And use the rest of the stack to buy an airplane ticket for all the Moslems here who want a FREE vacation in the south of France...

One way ticket....

yrad's picture

There can be only one reason why the End Game seems so ridiculously obvious to everyone but the experts at the Fed.. Theft.

Clockwork Orange's picture

They do indeed.  Its called pillaging.

Just keep the sheep anesthesized a little longer while you shift more wealth to your pals.



HopefulCynic's picture

And let me guess, you have principles and will not try to benefit, right? *wink

Is it me or no one in ZH wants to jump on this, we know it is going to get bigger before collapse, why not help them with the collapse and benefit in the process? What is 1 or 2 million more here and there? At least with what you get you can build a bunker or a shelter, buy some land in Brazil, or Costa Rica and watch as everything burns. 

The Merovingian's picture

Just remember, hogs get fat and pigs get slaughtered. Good luck with that though!

HopefulCynic's picture

But they do get fat first right?

It is just a matter of jumping out of the pen before you are to fat. 

August's picture

The planet's resources must flow to those with the ability to utilize them to maximum effect.

Why let some dumb-fuck orthodontist or, for that matter, public employee retirement plan, accumulate capital?

This is God's Work after all... and Darwin's too!

tdag's picture

Yellen: "Fire up those aircraft carriers. Gotta keep the petro dollar safe, so we can keep exporting inflation."

Infocat's picture

He´s still naive about the Globalists! http://www.truthjustice.net

NoDebt's picture

Why wait for the next recession?  Plan sounds so awesome we should just do it right now.



knukles's picture

Actually, having never yet left, we may already be in yeatsrday's recession today when declared effective tomorrow from some time in the future.
I shoulda writ Government survival pamphlets during the 50's. 

willwork4food's picture

Absolutely. I want a new truck for Christmas.

Pumpkin's picture

These people don't know what the fuck they're doing.


They know exactly what they are doing.

HopefulCynic's picture

Of course they do and you too. 

Are you jumping in to the bandwagon or no? You know things will get bigger, more money pouring down on us, just BTFD the sucker until it breaks. 

FEDbuster's picture

If anyone needs a laugh check out the FED's new Facebook page.  The comments are almost as good as the ones here.

Infocat's picture

LOL, yes they do, they know that they need to inflate the debt away! http://www.truthjustice.net

Chupacabra-322's picture

End Game is engineered Collapse, Civil War & or Nuclear War. Goal remains the same. Global De Population with Total Complete Full Spectrum World Domination over Humanity.

CPL's picture

The fact is they all die anyways by some method.  It's just no one wants to pull the trigger given the choices.  

a: Cover the lie of money by cutting off their own arms and legs,

b: Or let the lie continue by printing more.

It's just better to let them put that rope around their own neck while laughing hard and long.  They all deserve nothing less.  So stick around, the punch line to this joke takes forever but it'll be so worth it.

Mr. President's picture
Mr. President (not verified) Chupacabra-322 Aug 22, 2016 8:21 PM

Engineered collapse - absolutely. 

NUCLEAR  war? No. Never. That is a scare tactic for 'zhers and the like'. War will continue the way it has since the 80s. But tptb are long range thinkers.  Nobody will just get mad and ' hit the button' to launch.  Never.

If it did happen , then they lose too. And the ones that make the rules can not lose..Fuck , they invented the game, the rules, everything was completely planned before any 'zher' was born. (As much as zh wants y'all to believe that were on the eve of destruction. )

Don't forget, 'the scareder you are, the more zh profits.'(yes, even still).


Think people,  there 8s no nuclear war 8n anyone's future. 

Sounds like a great movie though. 

StillSilence's picture

Agreed its a scare tactic as well as another excuse to steal more earnings under the guise of nuclear arms race/development. Im not even convinced that these "WMDs" exist to the scale that is claimed.

BeansMcGreens's picture

A pressure cooker loaded with fireworks and the word "muslim" is enough to send a whole city into lockdown.

CPL's picture

Print more communist central bank jew confetti of course!  

They won't ever stop either because no one has given the authority to stop.  They need a bloodline to sit on their throne to declare a debt jubilee since all those 'royals' aren't really 'royal'.  They are given 0 authority to make any decision, and they know it.  If they were actually royals, one of them would have actually declared the debt jubilee by now.  Now sit back and watch it all burn to ground.  Believe me, it's for the best it all happens this way.

JRobby's picture

Then $40, then $80

The Fed will have the biggest balance sheet in the Universe AHHHHHHAAHAHAHHAHHAHHAHHAHHAHHHAHAHHA sigh.

taggaroonie's picture

"...next time it will be $20 Trillion."

but that will only be $2 trillion in today's money

NoDecaf's picture

"This time it will be $4 Trillion, next time it will be $20 Trillion"


Then it goes back down to the billions after they start lopping off some zeros

rinse repeat

FEDbuster's picture

One of my Zimbabwe $100 trillion dollar hangs on the wall of my office as a constant reminder.  The FED has become the Bankster's cesspool and the government's credit card company.

East Indian's picture

Zimbabwe could have really earned some money by selling that $100 trillion note as a souvenir to collectors.

I also have one!

auricle's picture

$4T Will be the initial injection for TARP and Bank failure. To recover the economy, depends how long they want to prop it up for this time. I'd think QEinfinity so depends how long we make it before reset $8T to $16T. Since it's a global endeavor, they will take this experiment to its final conclusion.