The Federal Reserve made two key decisions at its December meeting: speeding up the printing presses and throwing the calendar out the window.
Today the members of the Federal Open Market Committee agreed to undertake what many are calling QE4—a fourth round of asset purchases done in the hopes of stimulating the economy. The committee has agreed to buy $45 billion in longer-term Treasury securities each month, on top of the $40 billion in mortgage-backed securities it is already purchasing under QE3, announced in September. The new program comes as a replacement for Operation Twist, in which the Fed exchanges $45 billion in short-term bonds for longer-term bonds each month. That program ends this month.
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But the committee also stopped putting an expected expiration date on low interest rates. In recent meetings, it had said it expected to maintain near-zero interest rates at least through mid-2015. Today, the FOMC set thresholds for that interest rate’s duration, stating that it expects the federal funds rate will need to be low as long as the jobless rate is above 6.5 percent, shorter-term inflation is no more than 2.5 percent, and longer-term inflation is in check.
Some analysts expected such a move but thought it would come sometime in early 2013. Still, the committee downplayed this shift, stating that it “views these thresholds as consistent with its earlier date-based guidance.”
The committee in part explained its actions by expressing concern about the job market: “The Committee remains concerned that, without sufficient policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions,” the members wrote.
The new interest rate targets, says Greg McBride, senior financial analyst at Bankrate.com, are a way of providing busiensses and investors with something that is in short supply these days: certainty.
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“It saves this parsing of words and guessing game of Fed statements,” he says. “Markets can literally look at the numbers and gauge where the Fed is.”
Knowing interest rates will remain low for some time will ideally encourage both consumers and businesses to push money into riskier investments and ideally boost the economy, McBride adds.
Meanwhile, the question of whether continuing QE is a good idea is a question of whether its past iterations have worked. While easing has definitely stabilized markets, says one expert, understanding its effects is difficult.
“Everyone wants to pick their favorite economic indicator and use that to evaluate ‘Does it work?’,” says Robin Lumsdaine, a former Fed official and a professor of international finance at American University’s Kogod School of Business. However, she says, it may not be until the Fed exits from its easing programs that economists will be able to truly evaluate the effectiveness of easing.
Further complicating any analysis of recent Fed actions is the fact that the central bank is not operating in a vacuum; external factors, from the fiscal cliff to the European debt crisis, make it difficult to disaggregate which stimulative policies have worked, and when.
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While QE4 may have some stimulative effect, each successive round of easing likely has a smaller and smaller impact on the economy, says John Canally, vice president and economist at LPL Financial. However, he says, the Fed should remain vigilant about the potential downsides to such a massive balance sheet expansion.
“When inflation comes, it’s going to be something to worry about,” he says
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