Esther George, Kansas City Fed President, is a hawk among doves. Here’s why she’s concerned about what’s ahead for the economy, thanks to QE. Read more...
First, the central bank said it would increase the amount of quantitative easing by replacing Operation Twist, which ends Dec. 31, with outright purchases of long-dated Treasury bonds.
Under Operation Twist, every month the Fed sold $45 billion in short-term Treasury bonds and notes and bought $45 billion of long-term Treasury bonds in an effort to keep long-term interest rates low.
Because the Fed funded its purchase of long-term bonds with the sale of short-term bonds and notes, no new money was created.
However, outright purchases of long-term bonds will create new money-$45 billion every month-and, by concentrating its buying at the long end of the yield curve, the Fed should be able to keep long-term interest rates low.
The Fed also said it will continue to purchase $40 billion of mortgage-backed securities each month, creating a total of $85 billion in new money from these operations monthly.
That means QE4 is here.
Starting in January, the Fed will be more than doubling the amount of money it is pumping into the economy. Happy New Year!
Second, the Fed set unemployment and inflation "thresholds," instead of setting a date for when the central bank expects to be able to raise interest rates. What this means is that the Fed will not raise interest rates unless unemployment is 6.5% or less or inflation is more than 2.5%.
By setting thresholds where monetary policy might change, the Fed is attempting to improve its communications with the public.
And in an additional unprecedented move from the central bank, interest rate decisions will now be tied to the unemployment rate and inflation.
About a half hour into the release, the Dow Jones Industrial Average staged a near 65-point rally - but then lost that gain and ended down nearly 3 points at 13,245.45.
Here's a breakdown of the FOMC meeting outcome.
Today's FOMC Meeting: QE4As expected, the FOMC meeting ended with a replacement for Operation Twist, the expiring program introduced in 2011 of swapping short-term Treasuries for longer dated ones. The goal of Operation Twist was to lower long-term interest rates to stimulate the U.S. economy.
The new asset purchase program is an extended arm of the Fed's familiar quantitative easing programs, and has thus been dubbed QE4.
Now with QE3 and QE4 together, the Fed will purchase a whopping $85 billion a month of Treasury securities, stacking the Fed's portfolio with government-backed investments for an extended period.
The buying spree will remain intact until the unemployment rate falls below 6.5% and inflation projections remain no more than half a percentage point above 2% for two years out.
The Fed also left interest rates at rock-bottom historic lows near zero, as was also expected.
While these moves were widely expected, what wasn't expected was the Fed's forward-looking guidance.
The consensus is that the Fed will purchase an additional $45 billion of bonds from the secondary market each month.
That means the Fed would replace the monthly $45 billion used to swap short-term Treasuries for long-term Treasuries under Operation Twist, which expires at the end of this month, with outright bond purchases.
In addition to the $45 billion a month used in Operation Twist, the Federal Reserve Bank has been purchasing $40 billion of mortgage-debt securities monthly in its continued effort to boost growth.
In total, the market expects the Fed to continue to purchase $85 billion worth of bonds on the secondary market each month for the foreseeable future.
Now some investors fear the Fed with QE4 will seal the deal on skyrocketing inflation - but it takes more than increased money supply to raise prices.
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As central bankers gathered Tuesday for the last policy meeting of the year, expectations were high that Fed Chief Ben Bernanke and his cohorts will announce a large scale asset purchase plan to replace the soon-to-end Operation Twist, introduced in September 2011.
The Fed hopes additional stimulus will finally boost growth and the employment level. With the current unemployment level at an elevated 7.7% -- a number that economists say will be revised higher in the coming weeks - the weak labor market remains a grave concern.
At recent meetings, the Fed indicated that it will continue QE3, the policy of buying $45 billion in mortgage-backed securities each month until it sees a significant and sustained improvement in the employment scene - which is unlikely to come anytime soon.
Together with Operation Twist, the two programs added some $85 billion in long-term bonds to the Fed's balance sheet each month.
The aim, the Fed said in a statement, "should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative."
The central bank has also stressed it would employ its other policy tools "if the labor market does not improve substantially."
While the Fed did not elaborate on what those tools are, it maintains it still has plenty of ammo left and stands ready to pull the trigger when and if necessary.
It looks like now is the time.