Tea Leaf: The Fed continues to try to jump-start economy

Published: Tuesday, Sept. 27 2011 3:26 p.m. MDT

Federal Reserve Chairman Ben Bernanke

Susan Walsh, FILE, Associated Press

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The Federal Reserve in recent days announced its latest effort to boost the lagging U.S. economy. Whether this latest move will have much impact is open to debate.

More than three years of largely unprecedented monetary policy initiatives to 1) avoid an even deeper economic contraction during 2008 and 2009 and 2) to provide stimulus for renewed economic growth during 2010 and 2011 have shown limited success. Yes, the Great Recession from December 2007 to June 2009 was enormously painful and the longest in 70 years, but a downward spiral into another depression was avoided.

Yes, the American economy has registered growth since June 2009. However, the growth pace has been anemic, disappointing, substandard, and frustrating, especially when considering all of the various forms of stimulus at play in recent years.

The QEs

The Federal Reserve enacted two major programs during the past two years to stimulate the economy. The Fed's intent was to both inject more "money" into the economy to stimulate lending and investing … and to push medium- and long-term interest rates lower in order to make mortgage refinance or new home finance opportunities more attractive.

These programs, now affectionately referred to as QE1 and QE2 (quantitative easing), saw the purchase of more than $2 trillion in U.S. Treasury securities, U.S. Agency securities, and mortgage-backed securities.

Such purchases were essentially financed with newly created money. Many critics of the Fed have been savage in their opinions … and now see a major surge in inflation just around the corner.

The 'flations

It seems clear that Federal Reserve Chairman Ben Bernanke was more concerned 1-2 years ago about the potential ravages of deflation upon the economy, rather than "more traditional" inflation. One could suggest that his concern would now be somewhat balanced between the two 'flations. Even so, a number of media stories about rising deflation anxiety, tied to the substantial slowing of the global economy, have appeared in recent days.

In addition, the Fed's most important interest rate — the federal funds rate — has been at a record low target level of 0.00 to 0.25 percent since December 2008. The Fed has also taken the unprecedented step of suggesting that rate will stay at its current low level until at least mid-2013.

Operation Twist

The Fed's latest policy initiative does not involve the creation of new money to be invested into U.S. Treasury securities. Instead, it involves shifting $400 billion of the current investment holdings of the Fed to longer-dated securities (many with maturities of 10-30 years), with the intent … you guessed it … of pushing long-term interest rates — including mortgage rates — lower still.

Such transactions are currently scheduled to take place between next month and June 2012. One positive result of such a program should be the ability of larger U.S. companies to refinance their own long-term debt or issue new debt at extraordinarily attractive interest rates. Such a result could (hopefully) lead employment higher.

The Fed will sell $400 billion of securities with maturities of less than three years and reinvest the proceeds into securities with maturities longer than six years. As a component of the program, the Fed plans to buy $116 billion of U.S. Treasury bonds with maturities of 20 to 30 years. Such a sum would represent more than 80 percent of the net government issuance of new 30-year bonds over the same period according to The Wall Street Journal.

A similar program was first tried in the early 1960s, with the intent of keeping long-term interest rates at extremely low levels. Results were mixed at that time.

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