The Fed’s actions do not have a permanent effect on the money supply – that is, they result in a blip up which could be sustained, but we hope won’t be, because (as I understand) the supply increase was about 7%.
The faster that money moves around, the more efficient the system. The downside of fast moving money is that the system is sensitive to abrupt throttling, such as happens when a bunch of mortgagees stop paying their monthly bills. In a highly interconnected system – that is, with securitized mortgages – the effects of that throttling are felt far beyond the normal recipient of the mortgage payments. Stopping the money moving in one point means it has to stop moving in a bunch of other, related, areas. This is a liquidity crisis: It is fine when money stops moving slowly, but bad when it suddenly stops moving: You see things like jumbo mortgages at 8%, and funding for leveraged deals simply not being made available.
The Fed stepped in to flood the system with money in hopes that over the intervening days money can be pulled in from other areas to alleviate the crisis. This is the “stay of execution” you refer to. If the increase in the money supply is short-lived, the inflationary effect will be minimal.
The performance of the credit markets on Monday will tell us how effective the money bombing was.
The breadth of this issue illustrates just how bad the housing bubble actually is.
