Federal Reserve Chairman Ben S. Bernanke embarked on a historic test of unconventional monetary policy by using tools devised during the financial crisis to add fuel to an economy that’s been expanding for 15 months.
Bernanke’s Fed, constrained by a key interest rate near zero and bound by a Congressional mandate to reduce unemployment, yesterday said it would buy $600 billion in Treasury securities through next June in a bid to further reduce long-term borrowing costs and keep prices from falling.
The dollar weakened and stocks rose as the quantity of purchases exceeded the expectations of some investors. Bernanke is gambling he can push down a jobless rate that has been stuck above 9 percent since the recession ended in June 2009 and encourage investors to take more risk without igniting an inflationary surge or fueling asset-price bubbles.
“The Federal Reserve is under-performing on all of its objectives -- by law it has to do something,” said Allen Sinai, chief global economist at Decision Economics Inc. in New York. “I don’t think we pay them to sit on their hands and wait for good times. I will take any mistakes they make in return for the effort.”
Central bankers aim to accelerate U.S. economic growth above a 2.5 percent annual rate to push unemployment lower. The purchases, which come on top of $1.7 trillion of securities the Fed bought through last March to fight the financial crisis, equal roughly a 0.75 percentage-point cut in the federal funds rate, according to the Fed’s internal estimates.
The Federal Open Market Committee said in its statement yesterday that it was compelled to act because “progress” toward their objectives of full employment and stable prices “has been disappointingly slow.”
“The Fed’s statement is historic in its emphasis on the dual mandate, and doing quantitative easing in a non-financial crisis situation is historic,” said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. “They are clearly pretty serious about delivering” on jobs and growth.
Combined with about $300 billion in reinvestment of the Fed’s maturing mortgage bonds, total purchases could run as high as $900 billion, or about $110 billion a month, the Fed said. Some economists doubted whether the purchases would have much of an impact.
“I am hesitant to say it is going to yield the kind of impact we need to see to return the economy to trend growth,” said Timothy Duy, a University of Oregon economist who formerly worked at the U.S. Treasury Department. “I am not impressed by the magnitude.”
Fifty-three of 56 economists surveyed by Bloomberg News last week predicted the central bank would announce asset purchases yesterday, with 29 forecasting a pledge to buy $500 billion or more. Estimates ranged as high at $1.25 trillion.
New York Fed President William Dudley set expectations at $500 billion in purchases when he said in an Oct. 1 speech that purchases totaling about that amount would add as much stimulus as lowering the Fed’s benchmark rate by 0.5 percentage point to 0.75 percentage point.
The Standard & Poor’s 500 Index rose 0.4 percent to 1,197.96 in trading in New York. The Dollar Index, which IntercontinentalExchange Inc. uses to track the dollar versus the currencies of six major trading partners, lost 0.5 percent, and oil reached a six-month high of $84.69 a barrel.
Yields on U.S. 30-year bonds rose 0.11 percentage point to 4.04 percent after the Fed said it will buy fewer of the securities than investors anticipated.
Economists forecast the unemployment rate will remain at 9 percent or above until the first quarter of 2012, and hold at 9.6 percent when the Labor Department releases the October jobs report tomorrow, according to the median estimates in Bloomberg News surveys.
Among companies reducing staff is Norwalk, Connecticut- based Xerox Corp. The printer and business-services provider said Oct. 21 it would cut 2,500 jobs in the next 12 months.
“I’m still cautious on the economy, particularly in the large enterprise portion of the economy,” Xerox Chief Executive Officer Ursula Burns said on a conference call.
Yesterday’s Fed statement didn’t hold out any numeric benchmarks to measure success, nor did it discuss what would trigger more or perhaps fewer purchases. Instead, it referred to the central bank’s “statutory mandate.”
“The shift in rhetoric changes the debate from one of policy preferences and economic models to one of missed goals and binding obligations,” Feroli wrote in a note to clients. “The door for further action is clearly open if the committee doesn’t see sufficient progress in the economic outlook.”
A measure of inflation watched by the Fed, the personal consumption expenditures price index, minus food and energy, rose 1.2 percent in September from a year earlier, down from a 1.3 percent increase the previous month. Fed policy makers have a long-run goal of 1.7 percent to 2 percent inflation they see as consistent with achieving legislative mandates for maximum employment and stable prices.
Policy makers are concerned that a falling inflation rate increases the risk of deflation, or a general fall in prices that can strain consumers and businesses alike. Debt costs would rise in real, or inflation-adjusted terms, and because companies have many fixed costs, profits would erode, possibly leading to a cycle of job cuts, further declines in prices and collapsing demand.
“In the most extreme case, very low inflation can morph into deflation,” Bernanke said in an article published last night by the Washington Post. That can “contribute to long periods of economic stagnation.”
The Fed is already having an impact on expected inflation.
Inflation expectations, as measured by the so-called breakeven rate between yields on five-year Treasury Inflation Protected Securities and comparable conventional notes, increased to 1.47 percent yesterday from 1.19 percent on Aug. 27, the day before Bernanke said the Fed “will do all that it can” to keep the recovery going.
“They don’t want inflation to fall anymore,” said Jim O’Sullivan, chief economist at MF Global Ltd. in New York. “They are happy that inflation expectations have backed up over the last couple months.”
Bernanke’s renewal of asset purchases completes a policy U- turn this year. In February, the Fed raised the discount rate, charged on direct loans to commercial banks, to 0.75 percent from 0.50 percent. In March, it ended purchases of mortgage- backed debt begun during the crisis. Bernanke testified before Congress in March and July on how the Fed would pare back record stimulus.
Then, with the recovery slowing, the Fed in August decided to halt the shrinking of its balance sheet by reinvesting maturing mortgages into new Treasuries, setting a $2 trillion floor on asset holdings. Bernanke kept the door open for further action in a speech to central bankers at the Kansas City Fed’s annual symposium in Jackson Hole, Wyoming, on Aug. 27.
Returning from the Labor Day holiday on Sept. 6, U.S. central bankers also began to realize that another round of fiscal stimulus was a dead issue before the U.S. mid-term elections. Republicans captured a majority in the House of Representatives and narrowed the Democratic majority in the Senate on Nov. 2, capitalizing on voter concerns about government spending.
“The Federal Reserve cannot solve all the economy’s problems on its own,” Bernanke wrote in the Washington Post article. “That will take time and the combined efforts of many parties, including the central bank, Congress, the administration, regulators and the private sector.”
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