But the other thing to remember is that, like any farmer, the Fed doesn't control all the variables for growth. High household debt, a weak global economy, and awful residential investment are all contributing to our economic drought. The Federal Reserve doesn't have explicit answers for these problems.
Unlike Congress, it cannot send checks to families in the mail to raise income, or increase spending for defense contractors to raise employment. Instead, its policies can change expectations to encourage families and businesses to invest with confidence. By raising inflation expectations, QE can give the stock market a boost, and by lowering long-term interest rates it can encourage families to buy houses. You might say that a frothy stock market isn't exactly the most efficient way to help a lower-income family that's never thought about stocks in their life.
But, as I've written , a rising stock market isn't just good news for large companies and investors. It can also help overall consumer spending. In an impassioned defense of QE2, economist Martin Feldstein noted that the economy's strong rally at the end of was driven by a sharp increase in real personal spending, which in turn was driven by a decline in the savings rate and a sharp increase in the stock market.
Two weeks ago, Michael Woodford, a monetary economist, presented a very celebrated and wonky paper making a simple point. The Federal Reserve's greatest power isn't the ability to buy bonds. It's the ability to make promises. Martin Feldstein: What worries me about QE. Households continue to pay down debt, and are in no hurry to ramp up their spending.
That said, it's possible the Fed's move could help the housing market slightly. New construction and home prices have already started picking up recently, and should mortgage rates fall further , that could fuel a quicker housing recovery. The QE3 move comes after Bernanke has repeatedly urged Congress to do more to support the recovery in the short term, while still addressing the country's debt problem over the long term.
But Congress has done little to heed his advice, and given it's an election year, they're not expected to act anytime soon. Economists often cite the threat of fiscal cliff as one of the key reasons businesses remain reluctant to hire new workers.
The Fed may have acted Thursday, partly to offset the drag from fiscal policy. In implementing QE3, the central bank does not use taxpayer money to buy bonds. Rather, it expands the U. All of those could well be products of easing. Quantitative easing is supposed to work via a number of routes — it lowers the yield on bonds, sending people into other assets, particularly stocks.
So easing boosts the stock market. And it lowers longer-term interest rates, with the purpose of encouraging business borrowing and homebuying.
Because it's an indirect and unwieldy option, it is often referred to as a "blunt tool" — the Fed can encourage growth to happen, but it can't really directly cause growth to happen.
QE3 incentivizes risk-taking. It helps keep interest rates low. And QE3 did something extra to incentivize risk-taking. What separated QE3 from earlier bond-buying programs was that it was both monthly and open-ended. Because the Fed left it open-ended, it made it clear that the central bank was willing to keep its foot on the stimulus gas pedal until the economy looked healthier. One of the biggest fears of QE was that all of this "money-printing" would cause hyperinflation.
That still hasn't happened. The latest reading of personal consumption expenditures inflation the measure the Fed looks at is only at around 1. And that's not really changed, either, since QE3 began. One key thing to consider with QE3 is the counterfactual — what would the economy have looked like had it never been put into place? One of the big benefits of QE3 was that it counteracted a Congress that insisted on holding back spending, even while the economy was sluggish.
With low rates, households are more likely to take out mortgage or car loans, and businesses are more likely to invest in equipment and hiring workers. Lower interest rates are also associated with higher asset prices, increasing the wealth of households and thus driving spending. Bond purchases can impact market expectations about the future path of monetary policy.
QE is seen as a signal from the Fed that it intends to keep interest rates low for some time. Overall, the large-scale asset purchases that took place during and after the global financial crisis had powerful effects on lowering year Treasury yields. While previous rounds of QE primarily involved the purchase of longer-term securities, the Fed is currently purchasing Treasuries across a broader range of maturities.
The Fed has made clear that tapering will precede any increase in its target for short-term interest rates. So tapering not only reduces the amount of QE, it is also seen as a forewarning of tighter monetary policy to come, as was observed in the aftermath of the Great Recession. The combination of projected reductions in asset purchases and the possibility of higher rates in led to a period of high volatility and rising rates in the bond market—an episode that became known as the taper tantrum.
In response to the global financial crisis, the Fed began purchasing Treasury securities and mortgage-backed securities in The first two were for pre-announced totals.
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