The Federal Market Open Committee on its September meeting decided to undertake an open ended Quantitative Easing Program. The Fed launched its newest QE , or QEX as it is being called because of its open ended nature, in addition to keeping operation Twist operational. The Federal Reserve will buy 40 Billion dollars worth of mortgage backed securities every month until they see “sustained improvement in the labor market”. The Fed’s Chairman Bernanke also said that the Central Bank will undergo even bigger stimulus if conditions do not improve. The Central Bank also extended its commitment to keep rates exceptionally low until at least 2015.
The Fed here is basically counting on its theory being correct and is willing to print unlimited amounts of money until its proven correct, a very dangerous way of thinking in my opinion. The theory goes something like this: printing money will create a “wealth effect”. The Fed’s buying of MBS will lower rates on mortgages making houses more affordable and leading to more people buying houses, fueling GDP with their spending. The second wealth effect comes through the rising stock market, as people’s portfolio worth increases they may be more willing to spend their new found “wealth”. But the Fed has yet to explain why the previous QE actions did not substitutionally help the labor market and consequently why this newest action will help where they have failed.
“This is a Main Street policy, because what we’re about here is trying to get jobs going” Bernanke said and added: “We’re trying to create more employment. We’re trying to meet our maximum employment mandate, so that’s the objective.”
The Fed’s newest policy risks sparking inflation. Yesterday inflation expectations as measured by the break even rate for the 5 Year TIPS (Treasury Inflation Protected Securities) rose to their highest level since May 2011. They currently stand at 2.21% compared to 1.92% on August 30. Inflation as measured by the Fed’s preferred measure, the CPE, has not yet materialized in a big way and is hovering close to the Fed’s 2% target.
The low inflation was cited by Bernanke as one of the reasons or justifications for the FOMC action. The Fed has a dual mandate, price stability and employment and since there is no threat of inflation Bernanke said the Bank can focus on employment. But with inflation closely at their target right now, wouldn’t more QE now push it above the target?
The Central Bank slightly upgraded its projections on the economy, saying that growth will improve faster then the June outlook. The FOMC sees 2012 growth of 1.7-2% vs June’s forecast of 1.9-2.4%. For 2013 the Fed sees growth at 2.5-3% vs June’s 2.2-2.8% and for 2014 growth of 3-3.8% vs June’s 3-3.5%. On unemployment, the Bank sees the 2012 rate at 8-8.2%, unchanged from its June projection. For 2013 the Bank projects a rate of 7.6-7.9% vs June’s 7.5-8%. Finally for inflation, the Fed expects the PCE inflation for 2012 in the 1.7-1.8% range vs June’s 1.2-1.7%. For 2013 the Fed projects a PCE of 1.6-2% vs 1.5-2% in their June projection.