Fed follies: a more intelligent CP program

Updates in the news about the Fed's bulging commercial paper portfolio inspired an expansion of my earlier post about how the Fed could done this much more efficiently.

To illustrate how simple this could have been, think about bankers acceptances ("BA"). When a bank guarantees or "accepts" a trade-bill or letter of credit it stamps its acceptance on the bill or L/C. (I'm speaking of a paper-based world.) BAs are negotiable and desirable (as two-name paper) money market instruments. If the Fed similarly stamped its acceptance on CP they too become negotiable instruments. In fact, they become a form of currency! (Look at those bills in your wallet: they're no more than the Fed's promise to pay.)

This is money that does not show up on their balance sheet as it's only a contingent liability. I'm not sure what kind of "M" it would be (e.g., M3, monetary base), but it doesn't "crowd out" the normal functioning of financial markets.

JRB

2/3/09