Fed will spend $600B in latest bid to help economy
Thursday, November 4, 2010
WASHINGTON (AP) — The Federal Reserve will sink $600 billion into government bonds in a bold plan that it hopes will drive interest rates even lower than they already are and start the chain reaction that finally creates jobs and invigorates the economy.
The Fed said Wednesday that it would buy the bonds at a rate of about $75 billion a month through the middle of next year. The idea is to encourage people to spend more money and stimulate hiring, both ways of accelerating economic growth.
The announcement helped push stocks, which have been rising for weeks in anticipation of such a move, to their highest close of the year. But the program was immediately met with worries that it would not help enough and could backfire by causing inflation, creating asset bubbles and further weakening the dollar.
Even some analysts who were not concerned about such a backlash said the plan was unlikely to do much good.
“Bottom line: The plan provides a boost to the economy’s growth, but it is not going to solve our problems,” said Mark Zandi, chief economist at Moody’s Analytics. “Even with the Fed’s action, we’re going to feel uncomfortable about the economy in the next six to 12 months.”
The announcement came a day after voters frustrated by persistent unemployment and the limp housing market handed control of the House to Republicans and gave the GOP a bigger voice in the Senate.
The split will probably make it harder for President Barack Obama to enact any major economic initiatives and could put more pressure on the Fed to get the economy back on firmer footing.
The program is smaller than what Fed policymakers called their “shock and awe” approach to fighting the 2008 financial crisis. At that time, the Fed bought $1.7 trillion worth of securities.
This new program, including money that the Fed plans to reinvest from the portfolio of mortgages it has bought, should ultimately total $850 billion to $900 billion.
The Fed’s balance sheet, a measure of all its total holdings and investments, has ballooned to $2.3 trillion, nearly triple what it was at the end of 2007, when the economy slid into recession.
In addition to the Fed’s move, financial markets had anticipated the Republican takeover of the House for weeks and did not move much after the announcement. The Dow Jones industrial average finished up 26 points, about a quarter of a percentage point and good enough for a new high for the year.
Bond prices mostly rose. The huge demand from the Fed will make bonds more expensive and bring down the yields they pay out, which are connected to interest rates. The 30-year Treasury bond fell in price because the Fed is not expected to buy as many of those as other types of bonds.
In announcing its action, the Fed pointed out that the economic recovery remains slow. Companies are still reluctant to hire, housing activity is depressed, and Americans are increasing their spending only gradually.
Ten members of the Fed’s Open Market Committee voted for the program. The lone dissenter was Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, who said the program was too risky. Among his fears: The Fed’s plan will unleash inflation.
But Chairman Ben Bernanke said those worries are overblown.
“Concerns about this approach are overstated,” Bernanke said in an opinion piece scheduled to be published Thursday in the Washington Post.
With the economy weak, the Fed is aiming to avoid the kind of economic stagnation that gripped Japan and led to a “lost decade” during the 1990s. Japan is still recovering from deflation, the self-reinforcing cycle of lower prices, during that time.
The Fed actually wants to raise inflation from its current level, which is extremely low. Besides warding off deflation, a little inflation can be good for the economy, encouraging people to spend their money rather than save it.
Fed acknowledged that progress toward this goal has been slow. Among the bond-buying plans risks is that it will essentially work too well and drive inflation to dangerous levels.
Another risk is that it will sap more strength from the dollar, which is already weak, aggravating trade disputes with other countries. Flooding the economy with hundreds of billions of dollars that the Fed can essentially print at will dilutes the value of the existing dollars.
Some investors argue that it may also create price bubbles. If hedge funds and other speculators can borrow money cheaply and make even bigger bets on stocks, commodities and other international markets, the prices of those assets could be driven too high.
Beyond that, there is simply no guarantee that lower interest rates will make people spend more money or hire in great numbers. The economic recovery has been weak even with rates lower than ever. The national average for a 30-year, fixed-rate mortgage, for example, was 4.23 percent last week, near its lowest point in decades.
Lou Crandall, chief economist at Wrightson ICAP, said the Fed’s credibility is at stake. He worries that the Fed’s program creates an appearance of buying government bonds and printing money to pay for bloated federal budget deficits.
“This runs the risk of hurting the Fed’s reputation,” Crandall said. “This may come back to haunt the Fed.”
Zandi said he expects that even with the Fed’s additional help, the unemployment rate by the end of 2011 will be exactly where it is now, 9.6 percent. Without the Fed’s help, the rate would be 9.9 percent, he estimated.
In 2009, the Fed bought $1.7 trillion in mortgage and Treasury bonds. Those purchases helped lower long-term rates on home and corporate loans. The program was credited with helping to lift the country out of recession.
Zandi also estimates that the bond purchases will help the economy grow 0.3 percentage point faster in 2011, at a 2.7 percent rate. That’s still not as fast as the 5 percent growth economists say it would take to significantly bring down unemployment.
The Fed has tried since the 2008 financial crisis to make credit more available to individuals and businesses. It’s done so, in part, by keeping the target range for its bank lending rate near zero. But lending has remained frustratingly tight. And, unemployment has stayed persistently high.
“We could hardly be satisfied,” Bernanke said.
AP Business Writer Matthew Craft in New York contributed to this report.
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