The Federal Open Market Committee announced Thursday a new, open-ended program of buying mortgage-backed securities in the open market to push down mortgage rates and inject more money into the economy.
At the scheduled press conference that occurred after the announcement, Federal Reserve Chairman Ben Bernanke cited the continued struggles of the U.S. job market as the reason for the program, informally dubbed QE3, for the Fed's third round of quantitative easing in almost four years. Here are the big takeaways.
1. QE3 is about establishing credibility that the Fed will do whatever it takes to fight unemployment. Part of the reason previous rounds of quantitative easing haven't gotten job growth back on track is that the Fed hasn't sent clear enough signals to the market that it's committed to doing what it takes to increase employment, Bernanke said. As a result, the effect of QE on interest rates and expectations for future growth have tended to fade as each round of quantitative easing reached its conclusion.
In normal times, the Fed would just cut interest rates to signify its commitment to monetary easing. But with the federal funds rate at essentially zero, the Fed can't cut rates any further.
"Credibility is the key tool that central banks have to get traction at the zero lower bound," Bernanke said.
Translation: If we can prove to the market we're serious about fighting unemployment, no matter how much monetary easing it takes, then maybe we can finally get the economy out of this rut.
2. The Fed is very worried about the fiscal cliff. In January 2013, when the scheduled expiration of the Bush tax cuts takes place coupled with an automatic decrease in federal spending triggered by the debt-ceiling deal of 2011, billions of dollars will be sucked out of the U.S. economy, basically overnight.
If that happens, it would reduce the projected growth of the economy from 4.4 percent year-over-year to 0.5 percent. Bernanke said that while the Fed is committed to fighting unemployment regardless of fiscal conditions, there's not much he could do to prevent a massive economic slowdown under those conditions.
"If the fiscal cliff has the kind of impact the central budget office says it will, I'm not sure the Federal Reserve has the tools to deal with it," Bernanke said.
3. The Fed is not counting on, nor will it accept, significantly higher inflation. When asked whether an open-ended commitment to quantitative easing signaled that the Fed would tolerate higher levels of inflation, Bernanke responded that their inflation expectations hadn't changed much.
"We still believe that inflation is going to be close to our 2 percent target," he said.
That jibes with the projections released today by the Federal Open Market Committee, which projected inflation next year would be between 1.5 percent and 2.1 percent.
While those expectations may seem at odds with pumping what amounts to $85 billion in cash into the economy per month, Bernanke said the FOMC would keep a close eye on economic indicators, and adjust its purchases if inflation begins creeping up.
4. Low interest rates are a burden for savers, but a recession is worse. As low as interest rates are on savings vehicles, Federal Reserve Chairman Ben Bernanke wants you to know that it could be much worse. "It is difficult to save for retirement without the earnings you receive from employment," he said in today's press conference.
The central bank's policies are aimed at increasing the value of assets that Americans own such as homes and stocks. For instance, monetary policies that restore growth in the housing market benefit everyone by making it easier for people to make decisions about buying and selling homes, their employment options, and spending money.
5. Balance sheet actions such as QE3 are not a trickle-down policy. One criticism of previous easing programs is that they have helped Wall Street while not doing a lot for regular people. For instance, there are trillions of dollars' worth of reserves in the banking system, yet it remains difficult for many people to get credit.
Not so fast, "This is a Main Street policy," Bernanke said. The tools of the Federal Reserve affect the price of financial assets through a number of different channels. Mortgage rates, corporate bond rates and home prices were a few of the examples he gave.
"To the extent that home prices begin to rise, people may be willing to spend (money on) or buy homes, so home prices is one vehicle. Stock prices, many people own stocks. The issue here is: Are increasing asset prices making people willing to spend? If their 401(k) is up, maybe (they'll be) willing to spend, which is what firms need to hire and reinvest," Bernanke said.
In answering a separate question, Bernanke pointed out that lenders have been concerned with declining home prices, but as prices have begun to inch up in some areas, lending standards have eased a bit.
By: Claes Bell and Sheyna Steiner.