The Federal Reserve will spend $45 billion a month to sustain an aggressive drive to keep long-term interest rates low. And it set a goal of keeping a key short-term rate near zero until unemployment drops below 6.5 percent.
The policies are intended to help an economy that the Fed says is growing only modestly with 7.7 percent unemployment in November.
The Fed said in a statement issued Wednesday that it will direct the money into long-term Treasurys to replace an expiring bond-purchase program. The new purchases will expand its investment portfolio, which has reached nearly $3 trillion.
The central bank will continue buying $40 billion a month in mortgage bonds. All told, its monthly bond purchases will remain $85 billion. They are intended to reduce already record-low long-term rates to encourage borrowing and accelerate growth.
The Fed kept its target for its benchmark short-term interest rate at a record low near zero, where it has been for the last four years. The Fed said Wednesday that it would link any future rate change to lower unemployment, as long as inflation is expected to stay below 2.5 percent.
Before Wednesday, the Fed had said it planned would keep the rate low until at least mid-2015.
The Fed said it can pursue the aggressive stimulus programs because inflation remains below its target.
The statement was issued after the Fed’s two-day policy meeting and approved on an 11-1 vote. Jeffrey Lacker, president of Federal Reserve Bank of Richmond, objected for the eighth time this year.
The Fed’s final meeting of the year is being held against the backdrop of the looming “fiscal cliff,” the sharp tax increases and spending cuts that will hit the economy in January if Congress and President Barack Obama are unable to reach an agreement this month to avert them.
Bernanke has said that the Fed’s efforts will not be able to rescue the economy if the budget negotiations fail and the country does go over the fiscal cliff.
Fears of the cliff have led some U.S. companies to delay expanding, investing and hiring. Manufacturing has slumped. Consumers have cut back on spending. Unemployment remains elevated. If higher taxes and government spending cuts were to last for much of 2013, most experts say the economy would sink into another recession.
The latest bond-buying program would replace an expiring program called Operation Twist. With Twist, the Fed sold $45 billion a month in short-term Treasurys and used the proceeds to buy the same amount in longer-term Treasurys.
Twist didn’t expand the Fed’s investment portfolio, it just reshuffled the holdings. But the Fed has run out of short-term securities to sell. So to maintain its pace of long-term Treasury purchases and to keep long-term rates low, it must spend more and increase its portfolio.
The Fed’s portfolio totals nearly $2.9 trillion — more than three times its size before the 2008 financial crisis.
The Fed has launched three rounds of bond purchases since the financial crisis hit. In announcing a third program in September, the Fed said it would keep buying mortgage bonds until the job market improved substantially.
Skeptics note that rates on mortgages and many other loans are already at or near all-time lows. So any further declines in rates engineered by the Fed might offer little economic benefit.
Inside and outside the Fed, a debate has raged over whether the Fed’s actions have helped support the economy over the past four years, whether they will ignite inflation later and whether they should be extended.
The new policy amounts to complete reversal from the days when Fed officials prided themselves on their inscrutability. Fed policy has now become an open book, as predictable as the tides.
The Fed has long been tasked with two main responsibilities: Full employment and price stability. For years, Fed officials refused to be pinned down on exactly what those terms meant, on the grounds that flexibility was more valuable than precision.
But leading macroeconomists have been arguing that monetary policy can be more effective if the Fed gives precise numerical targets for unemployment and inflation. Clear communication actually makes the policy work better, they said. Today, the Fed agreed with those critics. Read Why the Fed’s words mean more than its actions.
A year ago, the Fed announced that price stability could be defined as a 2% annual increase in consumer prices. And today, the Fed announced that full employment (in this economy) means a jobless rate of 6.5% or less.
Furthermore, the Fed said it would allow inflation to run a little faster than its 2% target as long as unemployment remains too high.
This is a reversal of nearly 100 years of Fed policy that had accorded paramount importance to price stability at the expense of concerns about shortfalls in employment and growth. Now, the Fed has said that it will give equal time to inflation and growth.
In the current economy, that means the Fed is now unambiguously siding with the unemployed. The Fed is finally taking its full-employment mandate seriously.
That’s good news. The bad news is that the Fed has already done almost everything it can to get the economy up to full speed. The new policy announced Wednesday will likely give the economy only a slight boost.
[from the Washington Post, MarketWatch, and other sources]
As always, posted for your edification and enlightenment by
NORM ‘n’ AL, Minneapolis