“To support a stronger economic recovery …, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month.”
Rate Decision: Fed funds rate maintained at a range between 0 percent and 0.25 percent and a third round of quantitative easing (QE) is announced.
The Federal Open Market Committee announced QE3 today and the aggressiveness of the proposal was surprising. The Fed will buy $40 billion of securities that will be focused on the mortgage market and the time frame is open-ended. Indeed, the FOMC noted that: “If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.” Lower unemployment rates and faster job growth seems now to be job No. 1 for the Fed.
The way this policy will hopefully work is to drive down mortgage rates further, providing a boost to the housing market. This is the one segment of the economy that the Fed’s policy of QE seems to be having some impact. In addition, other policies already in effect, such as buying long-term securities and selling short-term ones and reinvesting proceeds will continue, and that will make sure the Fed is keeping all long-term rates low.
But the Committee didn’t stop with just QE and Operation Twist — or the long-term side of the policy coin. There was also an extension of the length of time that the members think short-term rates will remain low: Instead of mid-2014, the Committee now “anticipates that exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015.”
The basis for what are clearly extremely forceful actions is the FOMC’s worries about the economy. As the statement indicates, “the Committee is concerned that, without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions. Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook.”
While no mention was made of fiscal policy, I suspect that the aggressive nature of this action was taken because the members fear that a Congressional brain freeze could derail the modest growth pace that is currently being eked out. The Fed is providing the only support the economy is getting, as fiscal policy is already restrictive and running over the fiscal cliff could create a major recession. Add to that Europe and rising energy and food costs and the risks are more on the side of slower rather than faster growth.
By concentrating on the housing market, the Fed is admitting that its best bet to improve growth is by continuing to help this sector. That makes sense. The housing bubble bursting caused the recession and the excess construction last decade has limited current home construction. By keeping mortgage rates down, the members are betting that housing starts will accelerate, creating more jobs and income. Otherwise, there is little reason to ease further, as banks will not be lending more because there is additional liquidity and businesses will not be investing more because the uncertainties over the future are overwhelming the low rates. So it is housing or nothing.
Will the Fed’s actions work? My belief is that the Fed’s actions will keep the housing market recovery going, but it is hard to see how a few more basis points lower on a mortgage will cause a boom in demand. The problems of limited equity, tight lending standards and appraisal problems are still out there limiting the Fed’s effectiveness. At least the Fed members can say they are trying. That is more than what we can say about Congress.
© 2013 Moneynews. All rights reserved.