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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Fuku Ben's picture

Not 1 more cent.

NYPoke's picture

I'll donate $100 for pitchforks & torches.

Mass_hysteria's picture
Mass_hysteria (not verified) Aug 22, 2016 2:17 PM

They made us believe paper had any value.

Scary thing is majority of the people on this planet believe it has value. People like you and I...we are in the minority.

ZeroPoint's picture

Everyone has to play the paper game until the day it's over. Just keep stacking your beans, bullets, band-aids, bullion, and best buddies with your extra paper.


LadiesLoveCoolJames's picture

Let's not get too too nutty about paper money. I can still hand over a briefcase full of the shit and buy a ranch, an island or a large farm. I can also purchase weapons, food and vehicles. It has value as long as society accepts it in return for property and goods.

BandGap's picture

Somebody had something to say about this 50+ years ago.


Captbill98's picture

That road, you know, the one the can gets kicked down, suddenly has no end.

ejmoosa's picture

Turning Japanese...at least The Vapors were having fun.


VarenneRiver's picture

I'd rather have a shock than monetary theft and slavery...

Kirk2NCC1701's picture

"Better an End with Horror, than a Horror with no End." is how I frame it.

ZeroPoint's picture

Hmm, could it be that some Silverstein type gave the word to pull Douche Bank? Or is this just because there are no more buyers for treasuries other than the Fed?





Bill of Rights's picture

They mean to keep Gold at bay....JDST...

IronPyrite's picture

Albert Einstein said the definition of insanity is doing something over and over again and expecting a different result.

Mass_hysteria's picture
Mass_hysteria (not verified) IronPyrite Aug 22, 2016 2:21 PM

Thats a damn good quote

south40_dreams's picture

And it all goes to banksters and foreigners. Main Street can suck eggs

RawPawg's picture

checking my pants pockets to see if i got that amount to cover them.

hang on.....

Bill of Rights's picture

You have pockets? man you must be rich.

BandGap's picture

That's four thousand billion, give or take.



slightlyskeptical's picture

$4 Billion is enough to give every household $24,000 per year. 

Enough of this debt based money. Just print the $4 trillion and give it to the citizens. That will guarantee an economic recovery. Kill the fractional reserve system at the same time and you would see economic growth without inflation for many years to come. To keep it in balance, tax estates over $10 million at 70%. This would return enough money to treasury to keep inflation in check pretty much forever.

bid the soldiers shoot's picture

four thousand billion


and Bill Gates only has 90 billion


what a four flusher

RougeUnderwriter's picture

Got a problem?  write a check!!

froze25's picture

Can you write yourself a promissory note and have your bank teller deposit for you?

Muppet's picture

I cringed seeing this headline.   ZH take a stand...  No more words about additional QE.   Just by printing this, it comes into discussion.   Time to vomit now.

Sudden Debt's picture

So... that's the same as saying that everything they said since 2008 where lies????




Let's all go to their Facebook page :)

this shit is getting worse by the day... 4 trillion... that's doubling their books... that will cause the national debt to explode to 28 trillion!!!


swmnguy's picture

The FED makes it clear that their only concern is the continuation of the biggest and best-connected insider crony finance corporations.

Not one penny spent so far has been actual stimulus.  Actual stimulus, on the scale of what's been burned on Wall Street, would have done one helluva job on America.

This $4 Trillion they're talking about?  That's about $12,500 per man, woman and child in America.  Send a check for that amount to  each, and you'd see some economic activity alright.  Add in the $12 Trillion or so that's already been pumped through Wall Street like formaldehyde through a cadaver, and every one of us could have gotten a check for $40,000 in 2009, and there'd be no need for the $12,500 to be sent out  today.

Sure, some of that money would have been spent on hookers and blow, and some might have been wasted.  Most of it though would have been spent on impact, paying off credit cards, student loans, fixing mortgages in arrears, or stuffed into IRA's and whatnot.  Some would have been spent to get reliable cars, a refrigerator that keeps cold things cold, and whatever else people needed but couldn't afford just yet.

That's stimulus.  This bullshit of running fake money through fake banks to fund various scams and flim-flams is not stimulus.  Sure, it stimulates Wall Street insiders, like a catlle-prod to the prostate, but that's not what Keynes or anyone else had in mind.

So what the FED is telling us is that $12 Trillion hasn't been enough to tire out the fraudsters, so they'll need a whole lot more because they just won't stop burning money, knowing no matter how they skin the sheep rather than shearing them, no matter how much money the steal or flat-out lose, the FED will reimburse them for all losses--as long as they maintain their insider status.  Be from India and write code from your parent's basement-BAM! They'll have you in the jug so fast your head will spin.  But steal so much the entire financial system is insolvent; not a problem.  The check is indeed in the mail.

swmnguy's picture

And the reason the FED didn't send everyone a check for $40,000 in 2009?  Because they knew full well most people would use it to pay down debt.  

If consumers had paid down most of their debt, there would have been a massive, immediate benefit to the economy.  Sure, there would have been consequences, but not as severe as those we face today, having racked up that same amount of public debt, but without having the benefits to show for it.

So why didn't the Fed do it?  There's the dead giveaway as to the FED's true intentions.  They work for the finance industry.  The last damn thing on Earth the finance industry, and therefore the FED, want is for the American consumer to pay down debt.  The debt-capacity of the American consumer is the last, best remaining growth medium in America's dying economy.  Trading in that debt is the last remaining growth industry.

They make it harder to avoid debt, they make it harder to take on less debt, they make it much harder to bankrupt out of debt.  Everything and anything to keep the sheep in the pen.  Because the debt is bought and sold on the secondary market.  The debt is the true currency of the US financialized economy.  The FED won't do anything that might, in any way, reduce the value of that currency.

That's why all this talk of "stimulus" and "the economy" is bullshit, when it comes from the FED.

slightlyskeptical's picture

Then they send out another $40,000. 

All evidence is an argument for a national income and the elimination of the debt based money, fractional reserve banking, taxes and the claiming back of the money through a draconian estate tax for estates above $10 million. There would be little need for charities in such a scenario, so you could reverse the favorable treament of foundations and various types of trusts. You can use and keep all you earn as long as you are alive, but after debt is when the taxman cometh.


East Indian's picture

absolutely true.


the money that the people borrow from the banks is concocted out of thin air. If all the people return it, however, the banks cannot make the money disappear into the ether - that will collapse the value of the banks. The banks never want you to repay your loans - and cetainly not at the same time.


It must be feeling heaven - to pluck "money" out of thin air, to loan it to people, and then enjoy a constant stream of tribute from them, forever...

orez65's picture

When one reads bull shit like this post, it is like reading the debates in the Middle Ages about how many angels could stand on top of a pin head.

Central planning of an economy does not work. 

Abolish the Federal Reserve !!!!!!!!!!!!!!!!!!!!!

Jethro's picture

$4 Trillion you say? Pshaw...that's nothing more that typing in a few more zeros. What was the problem? (sarcasm if you didn't catch it)

buzzsaw99's picture

okay class, would all you stupid bitchez please read the first sentence on that post it note? i'm getting really tired of the stupid shit so many write on here about the (spurious, and allegedly direct relationship) between the fed funds rate and t bill/note/bond rates.

Madcow's picture

The Onion nailed how this would finally go down many years ago - 



Nobodys Home's picture

I like the logo...a squid wrapped around the globe...chuckle...shudder

PN7's picture

Ten Trillion Dollars in debt...Those were the days!

PontifexMaximus's picture

Only 4 trillions? No problem for the printer(s). What do we get S&P wise? 20 - 30% plus or more?

xyzcracker's picture

Fed's dead baby, Fed's dead

buzzsaw99's picture

not before the pair of pliers and blowtorch treatment

nailgunner44's picture

You hear me talking hillbilly boy?

UnschooledAustrianEconomist's picture

And you will know I'm the Lord when I lie my vengeance upon you.

Awesame posting, pal!

SMC's picture

USD FRN is toast.  Supported only by "Buy our bonds or enjoy our bombs"...

Hitlary and the DNC for Prison 2016.


ipso_facto's picture

When will credit card rates go down to 10% during any of these scenarios?

luna_man's picture



The CRIMINALS will push as long as the people let them.


You'll know if or when the people have had enough...CRIMINAL bodies all over the place!

ejmoosa's picture

Most of us here know there is no way out of the corner they have painted themselves in to.

The sooner they admit it the sooner we can get this blood bath over with and start the real recovery.



joebren's picture

There they go again - model mastrubating.

whatamaroon's picture

Have y'all seen the new pokemon app? It's cool.