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The Federal Reserve Pulls the Trigger

When Fed President Ben Bernanke spoke a couple of weeks ago at the Fed’s meeting in Jackson Hole, it was clear that the Fed was concerned, and had its weapon drawn.

Last week they pulled the trigger.

After the Federal Open Market Committee meeting, the Fed announced that it will start a third round of quantitative easing (QE3, or economic stimulus) because “the committee is concerned that, without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions”.  The market took the news well – and rose to the highest level since 2007.

The first two rounds of stimulus started in 2008, and included asset purchases of $2.3 trillion.  That brought the Fed’s balance sheet to over $2.8 trillion.  With the third round, the Fed will buy $40 billion in mortgage-backed securities every month.  That will take the Fed’s money creation to over $3 trillion.

Total Assets of the Federal Reserve

But QE3 is different.  The Fed went all in on this round.  Unlike QE1 and QE2, this time the stimulus is open-ended.  There is no limit on the size or duration.  QE3 will be ongoing until the economy improves…and for a while after that.  The Fed is “not going to rush to begin to tighten policy…we’re going to give it some time to make sure that the economy is well established”.  Continuing to juice the economy even after it looks better is a bold and consequential move.

And unlike QE1 and QE2, this is explicitly tied to the job market.  QE3 will go on until the Fed sees ‘substantial’ improvement in the labor market.  Never before has the Fed (or any central bank) linked a quantitative easing plan to jobs.

QE3 has its critics.  The Fed is an independent, sort of quasi-government agency, and some say a policy move of this magnitude on the cusp of an election has a politicized feel.  The GOP is calling it a “bailout” for Obama’s economy.  And because the first two rounds of stimulus had an uneven impact on the economy, and didn’t bring the unemployment rate below 8%, some would say that printing more money is just an admission that QE1 and QE2 didn’t work.

Arguments aside, QE3 is an aggressive commitment from the Fed, and it is unprecedented.  Its impact on the economy will be determined in time, but for now at least, it’s giving the market a sugar high.


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