By Robin Wells
On Thursday, the Federal Reserve delivered a bold program of quantitative easing presaged by comments from Fed Chairman Ben Bernanke at the Jackson Hole economic symposium in August. Photograph: Reuters
“The stagnation of the labor market is a grave concern not only because of the enormous suffering and waste of human talent it entails, but also because persistently high levels of unemployment will wreak structural damage on our economy that could last for many years.”
This week, Bernanke assumed the obligation of those words as the Fed announced Thursday that it will engage in another round of quantitative easing – the so-called QE3 – through open-ended purchases of $40bn of mortgage debt per month. Furthermore, the Federal Open Market Committee (FOMC) declared its intent to hold the federal funds rate – the interest rate that the Fed directly controls – near zero “at least through mid-2015”.
The FOMC went on to say that “a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.” This was as bold a statement for loose monetary policy to support the economy as anyone could have hoped for.
Before last week, Fed watchers had predicted that Bernanke would wait until December or early 2013 to launch a new round. Some had charged that to act earlier placed the Fed’s reputation at risk, appearing as if it had intervened in a partisan fashion to help a struggling incumbent president during the last two months of a brutal presidential campaign. And, indeed, stocks soared after the Fed’s announcement.
Yet, last week’s jobs numbers were so awful – far fewer jobs created than expected in August, with many more people dropping out of the labor force, and the lowest labor force participation rate in 30 years – that Bernanke was forced to act regardless of purported appearances. More significant is the fact that in Thursday’s bold move of open-ended asset purchases and a firm commitment to loose monetary policy until the economy is clearly self-sustaining, Bernanke has finally acted to satisfy his critics who have complained for over a year that he has allowed himself to be bullied into inaction by withering criticism from Republicans.
The open secret of the present, post-crisis monetary state of affairs is that QE3 will have very little direct effect on the economy, just as the previous rounds of quantitative easing had very little direct effect. While the Fed needs to ensure that longer-term borrowing costs for households and businesses stay low, its billions of dollars of monetary intervention is too small to directly affect debt markets that are trillions upon trillions of dollars deep.
Out of tangible ammunition, all that Bernanke has left in his arsenal is his ability to manage expectations about the future. Specifically, what Bernanke must do is convince the markets that monetary policy will stay loose indefinitely into the future: that instead of obsessing about inflation, the Fed will act to rein in monetary policy only once employment has made a substantial recovery. And that also means a much more doveish attitude toward future inflation.