What is the Fed doing? Ben Bernanke attempts to communicate the Fed’s policy and the reasoning behind it:
What the Fed did and why: supporting the recovery and sustaining price stability, by Ben S. Bernanke, Commentary, Washington Post: …The Federal Reserve’s objectives – its dual mandate, set by Congress – are to promote a high level of employment and low, stable inflation. Unfortunately, the job market remains quite weak; the national unemployment rate is nearly 10 percent, a large number of people can find only part-time work, and a substantial fraction of the unemployed have been out of work six months or longer. The heavy costs of unemployment include intense strains on family finances, more foreclosures and the loss of job skills.
Today, most measures of underlying inflation are running somewhat below 2 percent, or a bit lower than the rate most Fed policymakers see as being most consistent with healthy economic growth in the long run. …
The FOMC decided this week that, with unemployment high and inflation very low, further support to the economy is needed. With short-term interest rates already about as low as they can go, the FOMC agreed to deliver that support by purchasing additional longer-term securities, as it did in 2008 and 2009. The FOMC intends to buy an additional $600 billion of longer-term Treasury securities by mid-2011 and will continue to reinvest repayments of principal on its holdings of securities, as it has been doing since August.
This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. …
While they have been used successfully in the United States and elsewhere, purchases of longer-term securities are a less familiar monetary policy tool than cutting short-term interest rates. That is one reason the FOMC has been cautious, balancing the costs and benefits before acting. We will review the purchase program regularly to ensure it is working as intended and to assess whether adjustments are needed as economic conditions change.
Although asset purchases are relatively unfamiliar as a tool of monetary policy, some concerns about this approach are overstated. Critics have, for example, worried that it will lead to excessive increases in the money supply and ultimately to significant increases in inflation.
Our earlier use of this policy approach had little effect on … broad measures of the money supply… Nor did it result in higher inflation. We have made all necessary preparations, and we are confident that we have the tools to unwind these policies at the appropriate time. The Fed is committed to both parts of its dual mandate and will take all measures necessary to keep inflation low and stable.
The Federal Reserve cannot solve all the economy’s problems on its own. That will take time and the combined efforts of many parties, including the central bank, Congress, the administration, regulators and the private sector. But the Federal Reserve has a particular obligation to help promote increased employment and sustain price stability. Steps taken this week should help us fulfill that obligation.
The purchase should have been much larger, and it should have involved longer term Treasury securities (the plan is for 5 to 6 year bonds). The language in the Press Release about maintaining stable expectations was also disappointing to those who have ben advocating a higher inflation target. This is not, by any means, a bold plan.
That’s unlikely to change. Even if the economy continues to struggle, it’s hard to imagine the Fed doing anything more than moving at a “measured pace,” a pace too slow to do much except chip away at the margins.
With fiscal policy out the window and a timid, tip-toeing Fed, we’re likely headed for an agonizingly slow recovery.
Originally published at Economist’s View and reproduced here with the author’s permission.