The Fed’s steps were in many ways remarkable: For the first time, it made a definitive promise that it would keep interest rates ultra-low even if the economy starts to recover. That sent a clear signal that for years it will be cheap for consumers to borrow to buy homes and cars or for businesses to get loans to expand.
To reinforce the point, the Fed said it will buy $40 billion per month in mortgage bonds in addition to $45 billion in Treasury bonds through the end of the year, a process known as “quantitative easing.” After that, the Fed will reassess its actions, but it is likely to continue buying tens of billions of dollars of mortgage bonds unless the economy suddenly shows signs of a major rebound.
Four years after the financial crisis nearly sent the nation into a depression, the Fed’s actions underscored both the painful slowness of the recovery and the reality that the central bank is the only government entity willing to do anything about it. Fed leaders are worried that growth remains lackluster even though the central bank has injected more than a trillion dollars of new money into the economy, defying fears of critics that such continued intervention could spark inflation. The Fed said it expects to support the economy at least through mid-2015.
“This is sort of like: Whatever it takes. It strikes me as one of the most aggressive statements of policy by a modern central bank,” said John H. Makin, a scholar at the American Enterprise Institute. “I think their fear is if they’re not this aggressive, the economy will just stagnate and we’ll have long-run unemployment, and a loss of productivity and a long period of substandard growth.”
Stocks rise on news
The stock market was buoyed by the news. The Dow Jones industrial average rose 1.55 percent, to 13,539.86, while the Standard & Poor’s 500-stock index climbed 1.6 percent to close at 1459.99. The yield on the 10-year Treasury bond fell nearly 2 percent.
In afternoon remarks, Fed Chairman Ben S. Bernanke explained that the Fed no longer expected economic growth to pick up enough to materially reduce the 8.1 percent unemployment rate. He said the Fed will remain vigilant in ensuring that the central bank’s efforts to stimulate the economy don’t lead to rising prices, but said he saw little risk the economy would “overheat” and cause inflation.
Addressing the plight of 12.5 million jobless Americans, Bernanke used evocative language that made him sound more like an activist crusading to help the unemployed than the reserved professor he once was.
“The weak job market should concern every American. High unemployment imposes hardship on millions of people and it entails a tremendous waste of human skills and talents,” Bernanke said. “Five million Americans have been unemployed for more than six months, and millions more have left the labor force, many of them doubtless because they’ve given up on finding suitable work.”
The actions taken Thursday marked a new chapter in the Fed’s approach to dealing with the slow economic recovery.
From 2008 through early 2010, the Fed intervened in the market to help end the financial crisis by cutting interest rates and buying up Treasury and mortgage bonds. Later in 2010, it launched a second round of easing, buying up Treasury bonds to fight deflation, or falling prices, a dangerous phenomenon that can wreak havoc on a nation’s economy and well-being.
Many economists say those actions prevented the economy from falling into a depression and helped support the economic recovery, the housing market and the stock market.
But the central bank seems to be acknowledging that its actions — providing people and businesses with an ample supply of cheap loans — have been inadequate. A critical measure of the labor market, the employment-to-population ratio, is worse than it was at the start of the year.
‘Lost decade’ feared
The Fed seems worried that the country could face years of high unemployment, a problem that could prevent the U.S. economy from ever regaining its luster. In other words, the Fed appears to want to avoid the type of “lost decade” that afflicted Japan, which suffered what economists call a liquidity trap when its economy didn’t grow despite extremely low interest rates.
It is difficult to precisely forecast the overall impact of the Fed’s new policies. Fed policy can work by lowering mortgage rates and boosting stock prices, but mortgage rates are already at record lows and stock prices are booming. Still, the policies should bring down mortgage rates even more — they have fallen about 1.5 percentage points over the past few years — and help support higher stock prices.
The Fed’s projections suggested that its new actions might bring unemployment down by about 0.4 percentage points more than otherwise would have occurred over the next two years. Bernanke predicted it might do more.
Columbia University professor Michael Woodford, who had been critical of the Fed’s strategy, called the Fed’s actions an “important and useful step, which should be more effective in increasing confidence that the economy will recover.”
The central bank projects the unemployment rate at the end of the year to be between 8 and 8.2 percent. It’s currently at 8.1 percent. It is expected to stay in the high 7s next year, then begin falling more rapidly in 2014. Even in 2015, the jobless rate could be as high as 6.8 percent.
The Fed’s actions Thursday are likely to inject it further into the political debate. Republicans and conservative economists have been hostile to the idea of new stimulus, saying it could unleash inflation and spur excessive borrowing by the federal government by keeping Treasury rates artificially low.
Fed officials have been sympathetic to concerns about inflation, which would first affect middle-class purchases of necessities such as food and gas. To date, however, there has been little evidence that inflation is a significant risk. The Fed seeks a 2 percent inflation rate, and recent inflation rates have been there or below.
The Fed is carrying the burden of acting to help growth in part because lawmakers have been mired in partisan gridlock. Members of Congress cannot agree on how to stimulate the economy in the short term or forge a long-term deficit reduction deal that would avoid the “fiscal cliff,” the series of automatic tax increases and spending cuts that, if allowed to happen, could send the economy into recession next year.
At his news conference, Bernanke acknowledged that the central bank could do only so much to address economic growth and, as he has done repeatedly, he urged the federal government to head off the threat of financial crisis.
“If the fiscal cliff isn’t addressed,” Bernanke said, “I don’t think our tools are strong enough to offset the effects of a major fiscal shock.”
GOP criticizes plan
The campaign of GOP presidential nominee Mitt Romney criticized the Fed’s plan. “We should be creating wealth, not printing dollars,” Romney’s campaign policy director, Lanhee Chen, said in a statement.
Sen. Charles E. Schumer (D-N.Y.) defended the central bank’s decision, saying: “The Fed is fulfilling its obligation to take action to address unemployment. Now congressional Republicans need to fulfill theirs.”
The Fed is acting amid some positive signs for the economy but also amid a number of deeply worrisome developments. The housing market, long depressed, has shown some hints of improvement. But the labor market has been worsening.
In the past three months, the economy has added an average of 100,000 jobs a month — not enough to keep up with the 120,000 or so needed to match the number of new people searching for jobs as a result of population growth. Employers need to generate closer to 200,000 jobs a month to significantly lower the unemployment rate.
What’s more, the economy still faces serious risks. Income was up only 1.4 percent in the second quarter, suggesting that consumers will have little to spend this holiday season, which could be a drag on growth. In addition, the U.S. economy faces a double threat abroad.
In Europe, officials have been taking some positive steps to stem the continent’s fiscal meltdown, but Europe is in recession, and the financial crisis persists. In addition, emerging markets, such as China and Brazil, are slowing down.