FT Alphaville:

There is another cost too. As interest rates move to zero, the Fed’s becomes less and less effective: low-yielding treasury bills are barely distinguishable from cash.
The answer to this is to expand the balance sheet: the Fed has to grow larger and larger to allow it to continue to affect rates.

This is all remarkably similar to the policy of quantitative easing adopted by the Bank of Japan in the 1990s. It’s odd really that the Fed is not giving much clarity on its actions. Odder yet that people aren’t looking to Ben Bernanke’s numerous papers on fighting deflation to see the germ of current policy.

We reprise the below, from 2002:

Bernankes comments

"So what then might the Fed do if its target interest rate, the overnight federal funds rate, fell to zero? One relatively straightforward extension of current procedures would be to try to stimulate spending by lowering rates further out along the Treasury term structure–that is, rates on government bonds of longer maturities. There are at least two ways of bringing down longer-term rates, which are complementary and could be employed separately or in combination. One approach, similar to an action taken in the past couple of years by the Bank of Japan, would be for the Fed to commit to holding the overnight rate at zero for some specified period. Because long-term interest rates represent averages of current and expected future short-term rates, plus a term premium, a commitment to keep short-term rates at zero for some time–if it were credible–would induce a decline in longer-term rates. A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years). The Fed could enforce these interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields. If this program were successful, not only would yields on medium-term Treasury securities fall, but (because of links operating through expectations of future interest rates) yields on longer-term public and private debt (such as mortgages) would likely fall as well.

My comment: The idea of a dollar devaluation as a way to interrupt a deflation from taking hold has been used several times in the previous century by US governments. Eric Janzen at Itulip has written several good articles on this in the recent past. This temporary spate of disinflation as opposed to a true deflation, which is a contraction in money and credit will be easily overcome by the FED. It will take some time and the after effects, a significant inflation, and the consequent price increases will be sure to follow.

John Polomny
The Real Deal