The Federal Reserve’s Federal Open Market Committee (FOMC) has decided to pursue additional monetary stimulus to prop up a struggling U.S. economy. Specifically, it will purchase $40 billion in mortgage-backed securities each month for an undisclosed time period. This will be in addition to its already existing policy of reinvesting principal payments in mortgage-backed securities.
The goal of doing this is simple. The Fed wants to “put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.” Already, the Fed’s actions have pushed mortgage rates to historic lows, helping to improve a still-depressed housing market.
The Fed also decided to extend its guidance regarding long-term interest rates. It is now specifically stating that it will strive for “exceptionally low” interest rates through mid-2015. It had been saying as much through the end of 2014.
In choosing to do another round of quantitative easing (QE), the Fed is reacting to slowing domestic and global economic growth. Market-watchers had widely anticipated a third round of QE (QE3), making today’s announcement less dramatic. In describing the current economic environment, the Fed’s statement said:
The Committee is concerned that, without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions. Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook. The Committee also anticipates that inflation over the medium term likely would run at or below its 2 percent objective.
The latter comment is a reference to moderate inflation levels, which are mostly in-line with the Fed’s stated target. The Fed has a statutory dual mandate to “foster maximum employment and price stability.” With weak – and slowing – economic activity and modest price growth, the Fed feels that it has some leeway to pursue additional accommodative measures.
Of course, these actions are also controversial. Some political and economic observers worry about the long-term inflationary ramifications of these moves. As with past statements, Jeffrey Lacker, the President of the Richmond Federal Reserve Bank and a noted inflation hawk, was the lone dissenter on the FOMC. He “opposed additional asset purchases and preferred to omit the description of the time period over which exceptionally low levels for federal funds rate are likely to be warranted.”
Aside from inflationary concerns, there are also discussions about how effective QE3 might be. Each successive round of easing has been less effective than the first, at least according to some measures. And, while purchasing additional mortgage-backed securities will succeed in pushing mortgage and other long-term interest rates lower, they are already at historic lows. The marginal benefits might be more incremental than hoped.
With all of that said, the Fed’s actions are mostly a testament to how worried the central bank is about future growth in the economy. Given the criticism that it will no-doubt face – especially in an election year – and with the U.S. economy still growing modestly, it obviously felt the need to make a statement by taking additional measures. It had to act now, if it was going to act, as it would not be able to do so again until after the election. By then, the economy might have weakened further, especially with the fiscal cliff looming.
Manufacturers, for their part, are equally worried, with slowing sales and anxieties surrounding the fiscal cliff hurting overall optimism. Just yesterday, we announced that the number of manufacturers who were “somewhat negative” in their company’s outlook doubled in the past three months, according to the latest NAM/IndustryWeek Survey of Manufacturers. It’s clear that Washington must act soon on moving forward with pro-growth policies to shore up certainty to give manufacturers the ability to grow and better comptete.
Chad Moutray is chief economist, National Association of Manufacturers.