The Federal Reserve took drastic new steps to stimulate the sluggish U.S. economy on Thursday, announcing plans to buy $40 billion of agency mortgage-backed securities each month, starting Friday.
In addition to embarking on a third round of quantitative easing, the Fed also extended its vow to keep interest rates at rock-bottom rates to mid-2015. Policy makers also decided to keep in place the Operation Twist program that swaps short-term bonds for longer-term assets.
The measures came as no surprise to most economists. Last month, Federal Reserve Chairman Ben Bernanke expressed "grave concern" about American jobs at the Fed's annual retreat in Jackson Hole.
Since then, the news has only gotten worse. Only 96,000 jobs were created in August, according to figures released by the Department of Labor last Friday. The unemployment rate fell from 8.3 percent to 8.1 percent, largely a function of people giving up looking for work altogether.
The unemployment rate will not get down below 7 percent until 2014, according to the Fed's latest projections. The Fed is now forecasting the unemployment rate will fall to a range of 7.6% to 7.9% in 2013 and to a range of 6.7% to 7.3% in 2014.
The vote to offer fresh stimulus was 11-1, with Richmond Fed President Jeffrey Lacker once again dissenting on grounds that the Fed needlessly risks inflation.
Critics worry high gasoline and food prices are already hurting consumer confidence, and QE3 may aggravate the situation.
And with lending standards still tight following the worst housing crisis in decades, skeptics say pushing down rates is unlikely to stimulate demand for housing, automobiles, or other big-ticket items.
Meanwhile, advocates of QE3 say the weak U.S. economy needs a major injection of the Fed's cash to stimulate aggregate demand.
Economic activity has continued to expand at a moderate pace in recent months, but growth in employment has been too slow, and the unemployment rate remains elevated, according to the Federal Open Market Committee.
Policy makers were concerned that, without further policy accommodation, "economic growth might not be strong enough to generate sustained improvement in labor market conditions."
The Fed also wants to insulate the economy from headwinds from Europe, where officials are battling to prevent a full-blown sovereign debt crisis.
"Strains in global financial markets continue to pose significant downside risks to the economic outlook," voting member of Fed said.
The central bank will buy $23 billion in September, and offered a conditional pledge to spend up to $40 billion every month until the U.S. jobs market shows sustained improvement. The open-ended nature of the plan means the Fed will likely spend about $500 billion over the next twelve months.
Bernanke will offer further details and explain the rationale behind the Fed's big decision at a press conference scheduled for 2:15 pm ET.
by RTT Staff Writer
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