Posted on September 13, 2012

Fed Takes Bold Action

“The Committee is concerned that, without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions.”

QE3 has begun. The Fed will purchase additional agency mortgage-backed securities to the tune of $40-billion a month. Some doves had hoped they would leave the amount unspecified for maximum effect and flexibility. Others thought they would delay QE3 until December, after the election, as Operation Twist ends. They are very clear that current quantitative easing measures will continue and all principal and interest payments on their current bond holdings will be reinvested in MBS.

The total MBS investment will be a whopping $85 billion each month through the end of the year and they leave the door open to continuance beyond that period. The Fed is targeting further reductions in long-term interest rates, especially mortgage rates, and helping to ease further credit conditions in all markets.

It doesn’t get any clearer than that. Moreover, the Fed has committed to do whatever it takes (in essence) to reboot job creation. They will monitor it closely and they promise to extend and broaden quantitative easing into next year if the labour market is too weak. They will also consider all other measures under their control. They did add the proviso that they will do this in a noninflationary environment, but be sure that the Fed is not worried about inflation and indeed, inflation is going to remain of secondary concern until the unemployment rate falls sharply.

The icing on the cake is the Fed’s expectation to maintain a “highly accommodative…monetary policy…for a considerable time after the economic recovery strengthens.” Did you hear that? The Fed is aiming for maximum employment and price stability and they do not expect to stop until well after growth is above 2%. The cherry on the top is the extension of the expected period of very low interest rates tot hrough at least the middle of 2015 (rather than the end of 2014). The only opposing vote continued to be Jeffrey Lacker.

Bottom Line: The Fed is not playing tippy toe. The Fed is going use all the power it can muster to return the U.S. economy to noninflationary full employment. You can, and many will, argue that they won’t be successful, that they are either overdoing it or underdoing it, and that it will be vastly inflationary. Many will say the Fed is monetizing the debt and playing politics. But suffice it to say that the FOMC is determined to continue along this path.

They believe they will avoid an inflationary result by selling their bond holdings as and when it is necessary, reversing the quantitative easing and returning their balance sheet to more “normal” levels. My view is that this is a courageous move by the Fed and I applaud it. Rather than politicizing the Fed, it proves they are independent and willing to do what they believe is right regardless of the political fallout. No doubt, they will come under tremendous criticism from politicians and others; but Bernanke has already shown himself impervious to these outside pressures and willing to pursue this path.