I want to explain why everyone is so excited about what the Federal Reserve did yesterday. But I want to do it without using the words "quantitative easing," because those words are almost designed to get you to give up and stop paying attention.
Imagine you got a choice of superpowers. You could be invisible, you could fly, you could be really strong, or you could create unlimited amounts of money. You might well choose the money one. The other ones are cool for a bit, but they’re not all that versatile, and they may well get you into trouble.
The best way to think about the Federal Reserve is that it basically has a superpower. It can create as much money as it wants. Real, American money.
And the Fed doesn't need anybody’s permission. It’s not like when the president says he wants to do something, like the American Jobs Act, and you have to ask, “What does Congress think?” Or when John Boehner wants to pass something, and you have to ask, “Well, what does Harry Reid think?” Once the Board of Governors decides to move forward, they don’t need 60 votes in the Senate — they just do it. And that makes them incredibly powerful.
But, as Spider Man would say, with great power comes great responsibility. And so the Fed is very cautious in using its powers.
By law, it needs to try to keep unemployment and inflation low. Over the past two years or so, inflation has stayed low, and unemployment has been very, very high. But the Fed has not been doing all that much about it. It's been hoping the situation would turn around of its own accord, or that Congress and the president would stop bickering and unleash more stimulus — anything so that the Fed didn't have to further unleash its powers.
But it didn't happen. And so, on Thursday, Fed Chairman Ben Bernanke said the Fed had finally decided to do something about unemployment. Something big. Something that might actually work.
He said it was going to buy hundreds of billions of dollars’ worth of government and housing bonds for as long as it takes to get the recovery back on a solid footing, and then keep buying them for as long as it takes to be absolutely certain the recovery will stay on a solid footing.
The way the Fed’s plan works — if it works — is that buying all these bonds will drive down long-term interest rates, which will give businesses and investors more incentive to spend now as opposed to sitting on their money waiting for later. It will make mortgages even cheaper, which should accelerate the housing market’s recovery.
But the other part of the plan, and this part is really important, is that Bernanke just sent a signal to businesses and investors and the market and everyone else that the Fed is going to use its powers in a big, unusual way to get the economy moving. That’s a hugely important statement to make.
Imagine a business trying to decide whether it should hire more workers. The basic question it needs to answer is whether people will be buying a lot more stuff next year than they’re buying this year. If business owners don’t see any good reason to think the economy will improve, then the answer is probably, “No, people aren’t going to be buying more stuff next year,” so there’s no need to hire more workers.
But if they think the recovery is going to come, if they think people will be buying more stuff, then they need the workers. They don’t want to be caught without enough product — then their competitors would get those sales.
The Fed is trying to influence that decision. Fed officials are saying: “We’re going to use all our power to make sure there are people out there buying your stuff. So go hire. Do it now. We’re behind you.”
Or you can think of it this way. The Federal Reserve is kind of like the economy’s tough, older brother. If the economy is having problems with some kids at school, and the tough, older brother seems distant, or uninterested, then the economy’s in trouble.
But if the tough, older brother makes it clear that he’ll be there to back up the economy, come what may, and even says that he’s going to go have a talk with some of these kids tomorrow, then the economy is going to be a lot more confident walking to school from now on. And right now, what the economy needs, more than anything, is confidence.
Now, as some of us learned when we were young, tough, older brothers aren't invincible. And few economists believe that the Fed can solve our ongoing economic problems on its own. But it can do more to help then it's doing now, and with the housing market beginning to come back and Europe appearing to stabilize, there's a mounting argument that the conditions for a recovery are beginning to look pretty good. If there's a policy dark spot here, it's that Congress is still a mess, and there's no clarity as to how they'll bridge the fiscal cliff, or even if they'll bridge the fiscal cliff. And then, of course, there's the fundamental fact of the economy right now, which is that consumers are still digging out of debt and businesses remain skittish. Sometimes, even a big older brother isn't enough to make you feel better.
Further reading, which does include the words "quantitative easing":
- Dylan Matthews, on exactly what the Fed did.
- Brad Plumer rounds up the reactions to QE3.
- What the economists are saying.
- The Wall Street Journal editorial board is ambivalent.