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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The Navigator's picture

Not a problem, print all the fuck you want to, just don't do it on my (silver) dime.

BUT, I know THEY are coming for my silver dimes, quarters, and 1/2 dollars - like my arms/ammo.

Like Heston said, from my cold dead hands.

THEY will pay a heavy price.

Come thru my door, you will pay. I am not the terrorist. When you come thru my door, you are the terrorist, coming to steal my reserverd production.

Infocat's picture

Yes, Hyperinflationary collapse incoming! http://www.truthjustice.net

pundog's picture

I used to like the idea of a world that made sense.  It never did me a bit of good. 

LadiesLoveCoolJames's picture

They've made it work for 20 years and the entire country is rotting from Fukishima. Pretty impressive load of bullshit!

general ambivalent's picture

Yeah, but now at least you don't need to waste money on an oven to make your tuna melt.

Hitlery_4_Dictator's picture

Yea that's cool and all but I thought they fixed the issue with the last bailouts?  What am I missing here, I took them at their word since they have fancy degrees and use large, fake words that they conjured up out of thin air, much like their shit fiat. 

Nexus789's picture

Being exceptional and indispensable demands that you do. Even though it will be futile and ultimately destructive. 

HopefulCynic's picture

At least we know what is coming, meanwhile let's bubble this shit up, no? The bigger the better. 

You don't like profit?

Offthebeach's picture

In the old days of Japan a failed leader who brought dishonor would slice their own belly open and pull out with their own hands their intestines.

If you are reading this Yellen, you malignant toad, you financial terrorists,  forger of financial shackes, the great, greastest debt slaver, the final wealth destoyer of America and the world, with your black heart, that beats rivers of yellow green puss through your leaking veins, somewhere within you there must be a faint candle of humanity that will by God's grace, allow you a moment of atonement by elevator shaft, or street bus, the siren call of grabbing the third rail, or even a pint of vodka and sedatives.

Do the right thing, Janet. Make ammends. Buy a framing gun. Hitachi is a good brand, it's Japanese.

KnuckleDragger-X's picture

Trillions mean nothing when you own the magic money machine. With one push of a button you guarantee the Wall St. bonus's forever.....

Chupacabra-322's picture

Four Trillion in QE is code for: Americans 401k's should cover it. Along with thier bank deposits.

hound dog vigilante's picture


....w/ some superfluous currency printing on top... just for giggles.

JusticeTBuford's picture

What ink company should I invest in?

The Saint's picture
The Saint (not verified) TeamDepends Aug 22, 2016 11:14 PM

It's all electronic, Depends.  Take $40 and type 11 zeros behind it and presto.  $4 trillion out of thin air.  It's magic.

Priinting bills is old school.


Infocat's picture

The printing will not last forever, soon it will end! http://www.truthjustice.net



she has been through a Crash Course!!!

LetThemEatRand's picture

"That is the end of the dollar. ... Got PMs?"

Not sure this would really kill the dollar.  I used to think so, but now I realize most of that printed money goes to the .01%, and is not circulated into the general economy.  The whole world is complicit in keeping the dollar around, and the few countries that are not generally get bombed until a leader can be installed who sees it our way.  It definitely means the end of the middle class, which is already on life support, and at least some significant inflation.   But whether you're right or I'm right, PMs seem like the obvious hedge.

Consuelo's picture



 It's one of those processes (implementing alternative vehicles) that takes a while, and then it suddenly picks up pace faster than anyone expected.   


Toss in the military provocations going on in certain very dangerous neighborhoods around the globe where none were invited, and you have a recipe for some very fast changes.   None of which are destined to improve American's standard of living...

jewish_master's picture

big difference -awarness. think back how ur perception chaned from 2008 till today. i dont think ppl will acceptanother bailout. they cant sell it we all know th game

CJgipper's picture

Black lives matter.


You're living in a bubble.  The average American is not quite smart enough to be retarded.

Nobodys Home's picture

We have to pass it before we can see what's in it!

CuttingEdge's picture

Are you comparing congressional activity with taking a shit?

Only, the more I think about it...

KickIce's picture

Not sure if you've noticed but they're doing anything they damn well please these days and they don't give a rat's ass what you and I think about it.  They've even gone so far as to gloat about it re Greenspan and his "unintended consequences" and Rothschild "great monetary experiment" and the ruthless bastards can hardly contain their laughter throughout the interview.

HopefulCynic's picture

Hahahaha, you should know better, after all your people have done all that social engineering for decades. Hillary lies and people love her, Obama lies and people love him, congress supports him and people voted for him in the last elections. We've seen this over and over what makes you think your powers of manipulation are limited?

detached.amusement's picture

All that interest "we" "owe" is the boot on the neck

KickIce's picture

Bingo.  The Rothschilds have pretty much full control of the imaginary fiat world, imo it will take a real world event to bring this ponzi down.

GUS100CORRINA's picture


I will bet a lot more than 4 Trillion will be needed if a true 'ECONOMIC SHOCK' occurs. So let's review the financial accomplishments of America under the current DEMOCRATIC executive leadership.


1.) Student Loan Debt - 2 Trillion

2.) America's debt - UP over 100% in 8 years,

3.) America's unfunded liabilities - 150 Trillion plus and climbing rapidly

4.) Corporate Debt - Up over 100% in 8 years.

5.) Bank Derivative Expsosure - Up over 300% in 8 years.

6.) Crime and Violence - Out of Control (Billions in Lost Property, Lives)

7.) America's foreign policy - America now pays ransom to terrorists like Iran (400,000,000)

8.) State and Municiple Pension Shortfall - 6 Trillion

9.) Fed Balance Sheet - At 4.5 Trillion - Up Over 400% in 8 years


Well done Janet and Mr. President ... Well done!!!

WE ARE ON THE TITANIC AND WE HAVE HIT THE ICEBERG and everyone is more interested in straightening up the deck chairs!!!

May America R.I.P. Since America is most probably finished, let's make sure people in charge (DEMOCRATS) are finished as well.



indygo55's picture

You didn't even include the financial black hole known as the MIC.


KickIce's picture

They're going to need an extra set, or two, of books.

Scuba Steve's picture

Or derivatives betting ... especially the synthetics where the fundamental bet is made up.

NEWSFLASH: Derivatives are not just a balanced bet hedge .... there will be winners and there will be strategic, leveraged BIG losers

that matter to the economy.


cheech_wizard's picture

I need to hit the range more often.

And yes, you can be damned sure I'll be hunting Demonrats on the day of the collapse.

HopefulCynic's picture

Just go with it, youknow everyone else will, why not benefi from it. Just BTFD!

imbrbing's picture

You can throw alot of republican in that same pot.

bid the soldiers shoot's picture




The 4 trill is just to get the DOW over 20,000.

Nothing more constructive than that

Kirk2NCC1701's picture

The $4 Trillion is their Ante Up, to keep the Extend & Pretend of their Ponzi going a little longer.

Their models say it will work, so that's why they're doing it.

hound dog vigilante's picture


The $USD won't crash until there is a credible FIAT alternative for the banks, sovereigns & mainstream masses around the world to rush into... 


That fiat alternative to the dollar will be CNY and/or SDR's, and at this point in time neither is ready to assume reserve currency status.


When the CNY & SDRs are "called up" to the big leagues, then the $USD death watch can begin in earnest.

onmail1's picture

ObammaTheHomoJunkie screwed the dollar

Save gold

Ink Pusher's picture

Nixon screwed the Dollar, Clinton Buried it alive,Bush spent what was left from the insurance policy and Obama got stuck with the bill after the orgy-feast of 10 Trillion greenbacks was completed.   Get your American financial orgy history straight.

FixItAgainTony's picture

You forgot Wilson's 1913 treason.

Ink Pusher's picture

Wilson was dealing with a gold backed greenback. He had no excuse either.... but way before my time and not particularly relevant to the point.

FixItAgainTony's picture

I was referring to the Federal Reserve Act and the corrupting force of replacing an electorally controlled money supply with debt as currency.

Ink Pusher's picture

Carter Glass was the creator of the Fed Res Act  when Wilson was Sec.Treasurer.

This act was the progenitor for Glass-Stegall which has been badly " amended"

and then "nixed" by Clinton version 1.

Carter Glass made sure his banker buddies in VA  were taken care of right up to 1945.

Infocat's picture

This is an absolutely endless spiral of Debt Bubble building! http://www.truthjustice.net

BaBaBouy's picture

Sure Janet, We Know, just keep messing with GOLD ...

BandGap's picture

Have to ask why this discussion is going on in the first place.

Somebody peaked behind the curtain, perhaps?

CJgipper's picture




GunnerySgtHartman's picture

I look at it this way - the central bankers are telling us where not to put our money. :-)

Time to order more PMs.  Keep stacking, my friends.