Faced with an economy that has been weakening since April and economic forecasts that put GDP growth below 2% for the rest of the year and well in to 2013, the Federal Reserve today announced its third round of “quantitative easing” in an effort to stimulate a seemingly inert economy:
WASHINGTON — The Federal Reserve opened a new chapter on Thursday in its efforts to stimulate the economy, announcing simply that it plans to buy mortgage bonds, and potentially other assets, until unemployment declines substantially.
The Fed said that it would expand its holdings of mortgage-backed securities and potentially take other steps to encourage borrowing and financial risk-taking. But perhaps more significant was the basic change in its approach: For the first time, the Fed pledged to act until the economy improved, rather than creating another program with a fixed endpoint.
In announcing the new policy, the Fed sought to make clear that its decision reflected not only an increased concern about the health of the economy, but an increased determination to respond – in effect, an acknowledgment that its approach until now had been flawed.
The Fed also acknowledged its limits. “Monetary policy, particularly in the current circumstances, cannot cure all economic ills,” the Fed chairman, Ben S. Bernanke, said at a news conference.
The Fed’s policy-making committee said in a statement that its efforts would continue for “a considerable time after the economic recovery strengthens.” Specifically, it said it would act until the outlook for the labor market improved “substantially,” although it did not offer a numerical target.
In a separate statement, the Fed said its senior officials now expected the economy to expand from 1.7 to 2 percent this year, down from their June projection of growth of 1.9 to 2.4 percent. The officials continued to predict that the unemployment rate would not fall below 8 percent.
“The weak job market should concern every American,” Mr. Bernanke said at the news conference. “The modest pace of growth continues to be inadequate to generate much improvement in the current rate of unemployment.”
Fed officials predicted that growth would be somewhat faster in coming years, and that unemployment would decline somewhat more quickly, presumably reflecting the impact of the measures the Fed announced Thursday.
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In its measures, the Fed said it would add $23 billion of mortgage bonds to its portfolio by the end of September, a pace of $40 billion in purchases each month. It will then announce a new target at the end of this month, and every subsequent month, until the outlook for the labor market improves “substantially,” as long as inflation remains in check. The statement did not further explain either standard.
The Fed’s statement made clear, however, that it would continue to stimulate the economy even as the recovery strengthened, suggesting that it was now willing to tolerate somewhat higher inflation in the future to encourage growth in the present.
“A highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens,” the Fed’s policy-making committee said in its statement, issued at the end of its regular two-day meeting in Washington.
Asked what improvement in unemployment would satisfy the Fed, Mr. Bernanke said: “We are looking for ongoing, sustained improvement in the labor market. It is not a specific number we have in mind, but what we have seen the last six months, that isn’t it.”
The committee’s statement said that the Fed now expected to hold short-term interest rates near zero at least through the middle of 2015, and that it would take other measures as necessary – including purchasing other kinds of assets. The projections of senior Fed officials showed, however, that almost all of them expect to start raising short-term rates before the end of 2015.
This is, of course, the third time that the Federal Reserve has tried to use quantitative easing to resuscitate a sluggish U.S. economy. The first round occurred in the wake of the fall 2008 financial crisis and involved the Federal Reserve buying up Treasury Notes and Mortgage Back securities to the point where, by the early Spring of 2009, it had nearly $2 trillion dollars in assets on its books. The second round came in the fall of 2010 and involved the purchase of some $600 million in Treasury securities. While in both cases there is evidence that the measure helped stabilize the financial sector, especially the 2008-2009 asset purchases, there’s not nearly as much evidence to support the assertion that this is a practice that helps to stimulate economic growth in either the short or the long term. In fact, the only real effect from late 2010’s QE2 appears to have been an increase in stock prices which, based on the record of the economy over the past 18 months, seems to have had only a minimal impact on growth outside of Wall Street. So, there’s at least some reason to hold back on the optimism here unless, of course, you’re fortunes are tied to the S&P 500, in which case this is likely to turn out to be a pretty darn good deal for you.
Perusing the financial writers and pundits, one finds a mix of opinions today’s Fed decision.
Matthew Yglesias is quite optimistic:
This isn’t my dream of super-clear forward guidance, but it’s a huge step in the direction of Krugman/Woodford style precommitment. The key thing is that they’re no longer saying that accommodative monetary policy is conditional on the recovery being weak. Instead, interest rates will stay low for a while even after the economy recovers. In other words,build that apartment building right now.
I reserve the right to flip-flop, but my initial assessment is that this is a huge positive step.
As is Ezra Klein:
The Federal Reserve’s announcement Thursday is a big deal.
It’s a big deal because of what they’re doing. They’re buying $85 billion in assets every month through the end of the year, and then they’re potentially going to keep doing it in 2013. They’re promising to keep interest rates low through the recovery, and then keep them low after the recovery strengthens.
But it’s a bigger deal because of what they’re saying. Thursday, the Federal Reserve said, finally, that they’re not content with 8 percent unemployment and a sluggish recovery, and they’re willing to actually do something about it. If you’re an investor or a business owner trying to decide what the market is going to look like next year, you just got a lot more optimistic.
But Paul LaMonica argues that the Fed’s move isn’t likely to have much of an impact on the economy because the real work has to be done in Congress:
What’s needed to get the economy back on track is not more liquidity. It’s fiscal action by Congress. Getting the federal debt load under control, while simultaneously making sure that budgets for the government’s most vital programs, be that defense, education or social safety nets for the poor, are not eviscerated. Reforming an antiquated tax code. Regulating industries that need more oversight, while not going overboard with too many onerous rules.
Bernanke can’t change any of that. But with politicians too busy trying to get re-elected than actually governing, the Fed has no choice but to act more aggressively. There are legitimate fears that the lame duck (or is it just lame?) Congress will fail to reach an agreement before the end of the year to avoid the so-called fiscal cliff of automatic spending cuts and higher taxes.
In other words, the Fed may feel compelled to act merely to prevent a significant economic slowdown that could occur in the early part of 2013.
“QE3, QE4 or QE5 may not do much to boost the economy. The bigger issues are concerns about the election, regulation and the fiscal cliff,” said Wilmer Stith, manager of the Wilmington Broad Market Bond Fund (ARKIX) in Baltimore. “But there hasn’t been this much political uncertainty since the Great Depression and this is the worst possible time to have it. If we fall off the fiscal cliff, we’d likely enter another recession.”
And Walter Russell Mead that there’s actually more bad news than good in today’s announcement:
First, the fact that we need the help. That means that four years after the panic of 2008 the U.S. economy is not yet securely on track for a self-sustaining recovery (and Europe is in much worse shape). When the doctor says you need another operation, it means the first operation didn’t work. The Obama stimulus didn’t work; you can argue about who is responsible, but the basic argument is over why we failed, and there is no getting away from it.
Second, monetary stimulus on this scale really is a little bit like a powerful, mind-altering drug. You get a high going up, but coming down hurts—and over time it takes more of the drug to get the same result. The economy’s response to both fiscal and monetary stimulus looks a bit flabby these days—it seems to take a bigger jolt to get the same response.
Third, while there’s not a lot of inflation out there now (unless you look at energy, food, health care, education and gold—and who needs any of that stuff?), the risk that down the road some nasty turn of the screw could set off 1970s-style inflation is real. And with every round of stimulus those risks grow—unquantifiably, but they grow.
Inflation, of course, is the major concern any time a central bank increases the money supply — and, make no mistake, quantitative easing does increase the money supply — but so far, at least according to the official statistics there haven’t been many clear signs of inflation out there except the sectors that Mead mentions above. Likely, that’s due largely to the fact that the economy has been so weak relatively speaking that there hasn’t been a sufficient spark to set inflation off and running. Additionally, much of the monetary expansion still exists mostly on the books of the Federal Reserve which, by the end of this year, will hold more than $3 trillion in assets it has acquired since the 2008 financial crisis. At some point, those assets are going to come off of the Feds books, and cash will flood into the economy. Add to that the more than $1 trillion that banks are holding on to rather than lending at the moment and the cash being held on the books of major corporations, and you’ve got the potential for a fairly large expansion of the money supply, followed by its inevitable effect price inflation, just in time for when the economy really recovers, assuming it ever does.
The other thing to keep in mind is the fact that, as I’ve noted, the primary impact of QE1 and 2 seems to have been to boost stock prices. Indeed, Tyler Durden points to an interesting exchange during today’s press conference by Ben Bernanke:
QUESTION: My question is — I want to go back to the transmission mechanism, because speaking to people on the sidelines of the Jackson Hole conference, that seemed to be the concern about the remarks that you made, is that they could clearly see the effect on rates and they could see the effect on the stock market, but they couldn’t see how that had helped the economy.
So I think there’s a fear that over time this has been a policy that’s helping Wall Street, but not doing that much for Main Street. So could you describe in some detail, how does it really different — differ from trickle-down economics, where you just pump money into the banks and hope that they lend?
BERNANKE: Well, we are — this is a Main Street policy, because what we’re about here is trying to get jobs going. We’re trying to create more employment. We’re trying to meet our maximum employment mandate, so that’s the objective. Our tools involve — I mean, the tools we have involve affecting financial asset prices, and that’s — those are the tools of monetary policy.
There are a number of different channels — mortgage rates, I mentioned other interest rates, corporate bond rates, but also the prices of various assets, like, for example, the prices of homes. To the extent that home prices begin to rise, consumers will feel wealthier, they’ll feel more — more disposed to spend. If house prices are rising, people may be more willing to buy homes because they think that they’ll, you know, make a better return on that purchase. So house prices is one vehicle.
Stock prices — many people own stocks directly or indirectly. The issue here is whether or not improving asset prices generally will make people more willing to spend.
One of the main concerns that firms have is there’s not enough demand. There are not enough people coming and demanding their products. And if people feel that their financial situation is better because their 401(k) looks better or for whatever reason — their house is worth more — they’re more willing to go out and spend, and that’s going to provide the demand that firms need in order to be willing to hire and to invest.
So basically, what Bernanke is saying here is that the Fed has decided (with only one dissenting vote) that the best way to stimulate the economy is to create another stock market bubble. Pardon me, but haven’t we been here before? Didn’t we see the same thing happen in the 1990s with the Dot-Com Boom, only to see the market crash when reality set in, sending the economy into a recession. Didn’t we see it again in the 2000s when the Fed kept interest rates low to please the stock market, which was partly the cause of the housing market bubble that sent us into the deepest recession and weakest recovery since the end of World War II? And those are only the two most recent examples of artificially created asset bubbles, history is replete with many others both here in the United States and around the world (i.e., the Japanese real estate and stock market bubbles of the late 80s and early 90s from which that nation still hasn’t recovered). Do human beings not learn from history? (Who am I kidding? Of course we don’t)
In an ideal world, the Federal Reserve should have only one policy concern, maintaining the stability of the value of the dollar and prices in the economy as a whole. Indeed, that was essentially its sole mission when it was first created and for many decades thereafter. In 1978, however, Congress passed the Humphrey-Hawkins Full Employment Act which, among other things, required the Fed to also include as it’s goal maintaining so-called “full employment” and promoting economic growth. By doing this, Congress in many ways established essentially contradictory missions for the Fed because the policies that promote full employment often work against price and monetary stability, and vice versa. It is only, perhaps, because the Fed has been led for most of the period since then by Chairman who were very much inflationary hawks that we haven’t seen the full impact of those contradictions. Nonetheless, one can see some elements of that in Fed policy since 2008, which has been as much concerned with trying to create economic growth as it has been on the Fed’s original mission. The fact that those efforts have not worked very well would seem to indicate that the Federal Reserve Board isn’t really the appropriate entity for pursuing goals like economic growth. Indeed, Bernanke himself seems to recognize that when he says that it’s really up to Congress to fix our fiscal problems and get the economy moving again.
For the most part over the past 4 years, Fed policy has been very good for Wall Street, but not so good for Main Street. Given that track record, it seems unlikely that what the Fed announced to day is going to have any significant on the economy. But, hey, they’ll love it down at Goldman Sachs so that’s good, right?
