Fed to Begin Third Round of Quantitative Easing


 

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FED to Begin Third Round of Quantitative Easing


On September 13 the Federal Reserve announced that it would embark on a third round of quantitative easing, or QE3, to attempt to stimulate the economy and keep interest rates low through the middle of 2015 by purchasing $40 billion of mortgage-backed securities each month. The Fed said it will continue with this strategy until the labor market shows clear signs of improvement.

In addition, the Fed will continue with “Operation Twist,” which began earlier this year and is designed to keep interest rates low by selling shorter-term US Treasuries and using the proceeds to buy longer-term ones.

QE3 is notably distinct from QE1 and QE2 as it’s an open-ended program that will last until the economy improves. Unlike Operation Twist, which involves simply swapping one security for another, this new program will require an additional expansion of the Fed’s balance sheet to finance new securities purchases. There are several things the Fed is hoping to accomplish, including:

  • Providing price support and encouraging growth in the housing market
  • Incentivizing banks to expand lending, particularly for home mortgages
  • Spurring broad economic activity and improving the overall labor markets
  • Keeping long-term interest rates low to encourage businesses to spend and invest

As was the case in previous attempts at quantitative easing, this move will likely result in a great deal of political debate regarding both its effectiveness and whether the Fed should be expanding its balance sheet at a time when the national debt and annual deficits are of primary concern. The knowledge that interest rates will remain grounded for the next 30 to 36 months will also raise concerns about the long-term impact of intentionally keeping rates anchored to the floor for what will be a period of nearly seven years. A primary concern is that keeping rates artificially low may prop up home prices and the stock market temporarily, but it may ultimately cause the housing and stock market bubble of 2008 to reinflate.

The Fed is obligated under the Federal Reserve Act to seek maximum employment, stable prices, and moderate long-term interest rates. This is commonly known as the Fed’s “dual mandate,” and it influences all the policy actions it takes. The Fed’s intention with quantitative easing since 2009 has been to address its first and possibly third obligations under the act.

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