QE2: Fed pulls the trigger
Fresh YORK (CNNMoney.com) — In its latest stir to hop begin the sluggish recovery, the Federal Reserve announced it will pump billions into the economy.
The central bank will buy $600 billion in long-term Treasuries over the next eight months, the Fed said Wednesday. The Fed also announced it will reinvest an extra $250 billion to $300 billion in Treasuries with the proceeds of its earlier investments.
The bond purchases aimed at stimulating the economy — a policy known as quantitative easing — will total up to $900 billion and be ended by the end of the third quarter of 2011.
Ever since the Fed very first signaled back in August that it was considering a 2nd round of monetary stimulus, dubbed QE2, investors have been preoccupied with speculating on how much the Fed would buy.
Now the verdict is in, and is toughly in line with forecasts. Mainstream estimates had predicted a total inbetween $500 billion and $1 trillion.
“It was all largely as expected,” said Calvin Sullivan, chief strategy officer at Morgan Keegan. “The markets are responding as one would expect.”
Stocks seesawed inbetween gains and losses, as investors digested the news. The real surprise was in the bond market, where yields on the longer term 10-year and 30-year rose, after traders realized the Fed’s plan called for 91% of its purchases at shorter maturities than expected.
The Fed also reiterated its bearish view on the stalling economy, telling “the tempo of recovery in output and employment proceeds to be slow.”
Amid sluggish consumer spending, businesses have been reluctant to hire and the economy has grown at a snail’s tempo. At the same time, inflation is riskily low, causing some economists to warn that the United States may even be flirting with deflation — a debilitating drop-off in prices and request.
The Fed has already kept the federal funds rate, a benchmark for interest rates on a multiplicity of consumer and business loans, at historic lows near zero since December 2008. The Fed said Wednesday that it would proceed to hold the rate at “exceptionally low levels” for an “extended period.”
The federal funds rate is the central bank’s key contraption to spur the economy and a low rate is thought to encourage spending by making it cheaper to borrow money.
When already low rates failed to get consumers and businesses to spend, the Fed determined to resort to the more unconventional instrument of quantitative easing, to lower interest rates even further.
But critics of QE2, including some Fed members, believe that too much monetary stimulus might lead to runaway inflation that could derail the economy, or future asset bubbles that could endanger economic stability over the long term.
Other opponents have argued that it simply won’t work. The Fed already made almost $Two trillion in similar purchases during the Fine Recession, and current low interest rates have not jolted spending, they say.
“I don’t think this is going to make any difference at all,” said Paul Ashworth, senior U.S. economist with Capitol Economics, who feels the plan is too puny. “This is a lubricious slope. Once you’re on it, it’s very hard to get off.”
He predicts a repeat of what happened with the very first round of quantitative easing two years ago. The Fed primarily announced a $600 billion program in November 2008, but then four months later, enhanced that to $1.8 trillion, when it wasn’t enough.