The Federal Reserve will buy an additional $600 billion of Treasuries through June, expanding record stimulus and risking its credibility in a bid to reduce unemployment and avert deflation.
Policymakers, who said new purchases will be about $75 billion a month, “will adjust the program as needed to best foster maximum employment and price stability,” the Fed’s Open Market Committee said in a statement in Washington. The central bank kept its pledge to keep interest rates low for an “extended period.”
Chairman Ben Bernanke is trying to boost growth after near-zero interest rates and $1.7 trillion in securities purchases helped pull the economy out of recession without bringing down joblessness close to a 26-year high. He’s risking a strategy that may either fail or fuel inflation and asset bubbles, said Scott Pardee, a former New York Fed official who now teaches at Middlebury College in Vermont.
“Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the committee judges to be consistent, over the longer run, with its dual mandate,” the FOMC said. “Progress toward its objectives has been disappointingly slow.”
The dollar weakened and stocks fell after the announcement. Treasury notes were lower.
Including Treasury purchases from reinvesting proceeds of mortgage payments, the Fed will buy a total of $850 billion to $900 billion of securities through June, or about $110 billion per month, the New York Fed said in accompanying statement.
Duration of Assets
Assets will have an average duration of five to six years, and the central bank temporarily relaxed a 35 percent per-issue limit on its securities holdings “to provide operational flexibility” and buy the “most attractive securities on a relative-value basis,” the New York Fed said.
The FOMC kept its benchmark interest rate at zero to 0.25 percent, where it has been since December 2008.
Fifty-three of 56 economists surveyed by Bloomberg News last week predicted the central bank would announce asset purchases today, with 29 forecasting a pledge to buy $500 billion or more. Today’s action has been dubbed “QE2” by analysts and investors for the second round of a policy known as quantitative easing.
Central bankers in the world’s largest economy are struggling to bring down a jobless rate that has persisted at 9.5 percent or higher for 14 months. U.S. payrolls have declined for four straight months as employees hired for the census were fired and state and local governments eliminated positions to balance budgets.
The Fed’s preferred gauge for consumer prices, which excludes food and energy, rose 1.2 percent in September from a year earlier, the slowest pace since 2001. Fed policy makers have a long-run goal of 1.7 percent to 2 percent inflation they see as consistent with achieving legislative mandates for maximum employment and stable prices.
Bernanke, 56, a former Princeton University economist who studied the Great Depression, pressed forward with the move even after five of 18 policy makers went public with objections or doubts.
The one of the five who has a vote this year, Kansas City Fed President Thomas Hoenig, today cast his seventh straight dissent, the most at consecutive regular policy sessions since 1955. “The risks of additional securities purchases outweighed the benefits,” and the “continued high level of monetary accommodation” may eventually “destabilize the economy,” the statement said of Hoenig’s opposition.
U.S. real gross domestic product, which is adjusted for inflation, grew at a 2 percent annual pace in the third quarter, faster than the 1.7 percent rate between April and June yet still below what central bank officials believe is needed to reduce unemployment.
Economists in a Bloomberg News survey last month forecast the unemployment rate will average 9.3 percent next year. Fed governors and regional presidents presented updated economic projections at this week’s meeting and will publish them in minutes to be released Nov. 24.
Xerox Corp., the Norwalk, Connecticut-based printer and business-services provider, said Oct. 21 it would cut 2,500 jobs in the next 12 months. “I’m still cautious on the economy, particularly in the large enterprise portion of the economy,” Xerox Chief Executive Officer Ursula Burns said on a conference call.
At Bentonville, Arkansas-based Wal-Mart Stores Inc., sales at U.S. locations open at least a year have declined for five consecutive quarters. Target Corp., based in Minneapolis, said last month that it would lower prices on more than 1,000 toys to attract shoppers.
Still, the economy has shown some signs of a pickup. Retail sales increased more than forecast in September, and manufacturing expanded in October at the fastest pace in five months.
Stocks have climbed and the dollar weakened in anticipation of further Fed easing. Since Bernanke said Aug. 27 the Fed “will do all that it can” to keep the recovery going, the Standard & Poor’s 500 Index gained about 14 percent through yesterday, and the dollar declined more than 7 percent against a basket of six currencies.
Analysts differed on the market effects of the Fed’s action prior to the announcement. JPMorgan Chase & Co.’s chief U.S. equity strategist, Thomas J. Lee, said the purchases may spur the S&P 500 to rise 10 percent by the end of the year. Keith Hembre, chief economist at U.S. Bancorp’s FAF Advisors Inc., said that “to a large degree, QE is already priced in.”
Bond traders’ inflation expectations for the next five years, measured by the breakeven rate between nominal and inflation-indexed bonds, rose to 1.44 percent yesterday from 1.19 percent on Aug. 26.
Some measures of prices are gaining. Global food costs rose 26 percent in October from a year earlier, the fastest pace since 2008, according to the United Nations Food and Agriculture Organization. Gold futures traded in New York reached a record $1,388.10 an ounce on Oct. 14 and are up 23 percent this year.
“So far the Fed hasn’t lost its credibility, but it’s closer there than before,” Pardee said. “They’re still talking about easing even though the economy has turned into recovery and the financial crisis is past us.” In addition, “you have a lot of people in the market who are primed for seeing inflation around every corner,” he said before the announcement.
The Fed’s decision is the biggest in a marathon week of worldwide central bank meetings. Australia and India yesterday raised interest rates to cool inflation. Tomorrow, the Bank of England may leave the door open to more aid to the U.K. economy while the European Central Bank holds the line against price increases. The Bank of Japan on Nov. 5 may accelerate stimulus for its economy.
Bernanke’s renewal of asset purchases completes a full U- turn this year. In February, the Fed raised the discount rate, charged on direct loans to commercial banks, to 0.75 percent from 0.50 percent. In March, it ended purchases of mortgage- backed debt begun during the financial crisis. Bernanke testified before Congress in March and July on how the Fed would pare back record stimulus.
Then, with the recovery slowing, the Fed in August decided to halt the shrinking of its balance sheet by reinvesting maturing mortgages into new Treasuries, setting a $2 trillion floor on asset holdings. The next month, the Fed said it was prepared to ease policy if needed and said for the first time that too-low inflation, in addition to sluggish growth, would warrant taking action.
Bernanke and other Fed policy makers have since signaled the likelihood of printing money to start a new round of securities buying. “There would appear — all else being equal — to be a case for further action,” Bernanke said Oct. 15 at a Boston Fed conference. “The risk of deflation is higher than desirable.”
At the same time, “nonconventional policies have costs and limitations that must be taken into account in judging whether and how aggressively they should be used,” he said. One risk is that the public becomes less confident in the Fed’s ability to pare back stimulus and expects inflation above the central bank’s desired level, a concern Bernanke said would be “unjustified.”
Purchases of $500 billion would add as much stimulus as reducing the Fed’s benchmark rate by 0.5 to 0.75 percentage point, New York Fed President William Dudley, who serves as FOMC vice chairman, said in an Oct. 1 speech.
Not all Fed officials are so sure of the impact. Philadelphia Fed President Charles Plosser said Sept. 29 that he doesn’t see how additional asset purchases will help employment in the near term, and Narayana Kocherlakota of Minneapolis has said a new round would probably have a “more muted effect” than prior purchases.
“This seems to be about as sharp a set of divisions as I can remember in my experience,” said J. Alfred Broaddus, who served as Richmond Fed president from 1993 to 2004.
St. Louis Fed President James Bullard in July warned of a rising risk of Japanese-style deflation in the U.S. and called for purchases of Treasuries as a response to any negative shock. Japan’s economy has stagnated since the bursting of a stock- market and real-estate bubble in the early 1990s.
Consumer prices in Japan have fallen for seven of the past 10 years, and gross domestic product, unadjusted for changes in prices, was the smallest since 1991 last year. The country was overtaken by China as the world’s No. 2 economy in the second quarter.
The Bank of Japan started quantitative easing in 2001, pumping trillions of yen into the economy over five years through injecting funds into bank reserves. The funds sat static at commercial lenders’ accounts at the central bank and failed to spark business investment and consumption.
The Fed purchases announced today will add to the $981 billion of excess deposits that banks held at the central bank as of Oct. 20. Plosser said Oct. 22 that the funds are failing to spur growth now and are “kindling” for money creation and inflation in the future.
Call for Cooperation
In a 2003 speech on Japanese deflation, Bernanke called for “greater cooperation, for a limited time, between the monetary and the fiscal authorities” in the country, with Japan’s central bank increasing government-debt purchases “preferably in explicit conjunction with a program of tax cuts or other fiscal stimulus.”
Bernanke, who has been less explicit in seeking aid from U.S. lawmakers, may fail to win that kind of coordination in the U.S., especially after Republicans captured the House and Democrats held the Senate in yesterday’s midterm elections.
“We have an unhealthy focus on the Fed,” Vincent Reinhart, a former Fed monetary-affairs director who’s now a resident scholar at the American Enterprise Institute in Washington, said in a Bloomberg Radio interview before the decision. “They are the only game in town. They are the discretionary stabilizer right now for the U.S. economy, and therefore that puts more responsibility on them to act.”
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