The Federal Reserve, in a much-anticipated attempt to rev up the economy and fend off deflation, launched a new program this afternoon to inject $600 billion into the economy.
In its second round of “quantitative easing,” the policy-setting Federal Open Market Committee said it will create $75 billion in new dollars per month through next June and use them to buy long-term Treasury bonds. The goal is to push down the cost of borrowing for both businesses and consumers, and in turn to increase investment and spending.
In addition, the committee said it would continue to reinvest the proceeds from maturing mortgage-backed securities into Treasury bonds, effectively pumping what is expected to be an additional $250 billion to $300 billion into the economy at large.
The Fed’s move was in line with what many investors had been expecting, though analysts predicted that it would provide only a modest boost to the economy because interest rates are already at historic lows. But with Congress unwilling to pass any additional fiscal stimulus, whether in the form of tax cuts or extra spending, the Federal Reserve was the only other game in town.
Early signs from the bond markets - where long-term yields actually rose slightly - suggested investors may have been hoping for an even larger commitment from the Fed.
Announcing the quantitative easing, Fed officials pointedly left themselves room to change course, saying they would "regularly review" the program and adjust it "as needed to best foster maximum employment and price stability."
In a statement after the Fed meeting, the central bank expressed concern that "the unemployment rate is elevated, and measures of underlying inflation are somewhat low" relative to the Fed's unofficial targets. It also acknowledged that economic progress has been "disappointingly slow."
Analysts generally praised the scope of the move. Some said it would pack more economic punch if Congress were to follow up with a fresh round of fiscal stimulus to boost demand - a payroll tax cut, for example, or a new round of infrastructure spending. But such fiscal stimulus appears all-but-impossible in light of the midterm election results, which Republican leaders quickly hailed today as a victory for limited government and balancing the federal budget.
“It’s a good move," said Paul Sheard, chief global economist at Nomura Securities International. "We certainly think this is the appropriate thing for the Fed to do with its monetary policy. It’s quite impressive the way that the Fed has been able to steer the ship of monetary policy around in the last three months or so” - after appearing set to tighten the money supply this summer.
Later, Sheard added: “The conundrum is, from a macro point of view, in this kind of environment, you’d probably want to have more fiscal policy to put a little sting in the tail (if the Fed action), but that’s very hard to do politically.”
The Fed is charged by Congress with maintaining price stability and pursuing full employment, but both inflation and employment are below what Fed officials consider acceptable. “Quantitative easing” is an attempt to spur the economy at a time when the Fed’s traditional tool -- the overnight federal funds rate -- has at been at virtually zero for almost two years. By creating money and using it to buy long-term Treasury bonds, the Fed effectively pushes down long-term interest rates not only for Treasury bonds but for corporate borrowing, home mortgages, and other consumer lending.
The move could eventually boost inflation, but inflation is now running at barely 1 percent a year and is actually lower than the Fed’s unofficial target of 1.5 percent to 2 percent. Indeed, some Fed officials are openly worried about the possibility of a Japan-style deflation in which consumer prices fall across the board.
As recently as a few months ago, Fed officials had thought they wouldn’t need to embark on a second round of quantitative easing, or “QE 2,” as analysts have nicknamed it. In the first round of easing, which ended in March, the Fed bought about $1.7 trillion worth of Treasury bonds and mortgage-backed securities. But as the recovery flagged this summer and Congress balked at additional fiscal stimulus, Fed Chairman Ben Bernanke and other policymakers began to signal plans for a new round of printing money.
Few analysts expect the move to ignite runaway inflation. But the decision is not without its risks, particularly for Bernanke and the Fed's credibility.
Most economists consider quantitative easing a relatively weak tool to boost economic growth at the moment. The economy’s biggest problem is a lack of demand, not a lack of credit. Interest rates are low even for high-risk junk bonds, and corporations are sitting cautiously on large stockpiles of cash. Even if the Fed makes vast amounts of cheap money available, banks could end up parking much of it back at the Federal Reserve as dormant “excess reserves.”
Morgan Stanley analysts wrote last month that “the economic impact associated with this type of monetary stimulus is likely to be quite modest.”
Economists at High Frequency Economics were more blunt, writing before the announcement that “it’s hard to imagine a policy event being more discounted by the markets, and we are therefore a bit nervous about the scope for disappointment at the size of the QE program.”
The company's chief U.S. economist, Ian Shepherdson, was more upbeat after the announcement. He said the Fed decision was "a bit lower than some expected but will be enough, in our view, markedly to boost (money supply) growth, hold down (Treasury bond) yields and support further gains in the stock market. This is key because higher stock prices boost business and consumer confidence, hopefully triggering a virtuous circle of sentiment and spending. The dollar will likely suffer further declines; no bad thing."
Other analysts have worried that, if the easing fails to accelerate growth, investors could lose confidence in the Fed's abilities, potentially setting back recovery.
-NationalJournal
