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What Will The Fed Do?

Sep. 7, 2012 6:15pm

[Editor’s note: The following is an article by John Carney that originally appeared on CNBC.com]

Will the Fed Fire up Another Round of Easing?

CNBC.com senior editor John Carney

The disappointing jobs numbers Friday were quickly met with a consensus view on Wall Street that it is very likely that the Federal Reserve will take some action intended to boost the economy. But it’s far from clear what that action would be.

Last autumn, it seemed clear to many that the Fed was laying the groundwork for a new round of quantitative easing — QE3 — that would see the Fed buying mortgage-backed securities. That could still be in the cards, although improvements in the housing market may make it less likely.

The Fed actually has a number of policy options it could pursue apart from buying mortgages or any other bonds. It could, for instance, make a stronger commitment to keeping rates low for a longer period than the market expects, hoping that would spur increased economic activity.

The Federal Reserve believes that what it calls the “zero lower bound on nominal interest rates” limits its ability to reduce short-term interest rates. What that means is that since the Fed has already brought interest rates to near-zero on overnight borrowings in the Fed funds market, it cannot stimulate the economy by further lowering short-term rates.

Along with several other major central banks, including the Bank of England and the Bank of Japan, the Fed has developed “non-traditional” policy tools in an effort to provide stimulus, despite zero-interest-rate policies. These have included large scale asset purchases as well as the now familiar strategy of promising to keep rates low for an “extended period.”

The idea behind both these tactics — asset purchases and communicating Fed intentions — is to lower longer-term rates. It’s thought that the real economy typically is responsive to changes in long-term rates, so that lower long-term rates will result in easier financial conditions, stimulating economic activity and combating disinflation.

Last Friday in Jackson Hole, Wyoming, Fed Chairman Ben Bernanke gave a speech touting the effectiveness of “large scale asset purchases,” or LSAPs in FedSpeak. While noting that it is hard to “obtain precise estimates” about the effects of the Fed’s earlier rounds of quantitative easing, Bernanke said that there is “substantial evidence the Federal Reserve’s asset purchases have lowered longer-term yields and eased broader financial conditions.”

According to Bernanke, the asset purchases work in two ways.

The Fed’s buying of longer-term Treasury bonds and agency-backed mortgage bonds lowers the supply of these instruments available to private investors. This pushes their prices up, lowering their yields. Bernanke says there is evidence that movements of the bonds that the Fed buys ripple out to the rest of the market, pushing corporate bond yields lower and stock prices higher. The former makes financing new business activity through debt less expensive. The latter may create a wealth effect — investors see themselves as better off—that triggers new consumption and encourages further investment.

Will the Fed Fire up Another Round of Easing?

President Barack Obama & Federal Reserve Chairman Ben Bernanke (AP Photo/Gerald Herbert)

That sounds like a pretty ringing endorsement of asset purchases.

But this doesn’t mean we should rush to the conclusion that the Fed will definitely launch a new round of large-scale asset purchases.

There are good reasons to suspect that the Fed may try something different this time.

When the Fed first announced that it would buy agency debt (that is, debt issued by Fannie Mae and Freddie Mac) and agency mortgage-backed securities in November 2008, the rate on the 30-year fixed-rate mortgage was 6.69 percent. Last year, when the Fed started hinting at another round of buying mortgages, the rate was above 4 percent.

Today, the 30-year is down to 3.55 percent. Meanwhile, home prices in a majority of major U.S. markets are rising once again. This may mean that the effectiveness of a Fed mortgage-buying program could be quite limited. Rates likely won’t fall too much further and home prices don’t seem to need the stimulus they once did.

What’s more, the Fed already owns a tremendous portion of the mortgage market. Credit Suisse analysts pointed this out in a note last fall:

“The Fed currently owns roughly 15% of all Agency MBS, and just over 20% of fixed-rate conventional pass-throughs. If the Fed were to buy $500B of MBS as part of QE3, the numbers would jump to 25% and 34%, respectively,” Credit Suisse wrote.

The Fed is worried that owning too much of the agency mortgage market could create distortions and liquidity problems. Especially in an era when capital adequacy requirements on risk assets at banks are rising, having the Fed’s position grow too large could create unintended strains.

“Conceivably, if the Federal Reserve became too dominant a buyer in certain segments of these markets, trading among private agents could dry up, degrading liquidity and price discovery,” Bernanke noted in his Jackson Hole speech.

Another possible tactic the Fed could pursue, perhaps alongside a mortgage bond program, would be an extension of what’s known as Operation Twist but is officially called the “Maturity Extension Program.” Under this program, the Fed bought $400 billion of long-term Treasury bonds and sold the equivalent amount of short term bonds.

Operation Twist, launched about a year ago, was originally supposed to end this June but was later extended until the end of this year. The Fed could announce that the program will continue for an even longer period. Bernanke has described the effects of the Twist as “economically meaningful.”

Will the Fed Fire up Another Round of Easing?

President Barack Obama meets with Federal Reserve Board Chairman Ben Bernanke in the Oval Office of the White House in Washington, Tuesday, June 29, 2010. (AP Photo/Charles Dharapak)

Not everyone agrees that Operation Twist has had that great an effect. The program doesn’t expand the Fed’s balance sheet—it just adjusts the maturity of its holdings and therefore of the private sector’s holdings. It is a form of credit easing but not really a quantitative easing—the quantities of securities or dollars both at the Fed and in the private sector don’t change.

Twisting again also would run into obstacles similar to those the Fed faces in the mortgage channel. Interest rates are already at 50 year lows, with the 10-year now yielding just about 1.5 percent. And increased Fed ownership of long-term Treasury bonds could create liquidity problems.

But even if the direct effects would be limited, the Fed could announce a program to buy mortgages or an extension of Twist as part of a communication strategy. The purchases could be used as a way of showing the market that the Fed is very serious about aiding the economy and willing to expand its balance sheet in pursuit of economic stimulus.

In his speech in Jackson Hole, Bernanke noted that LSAPs “can signal that the central bank intends to pursue a persistently more accommodative policy stance than previously thought, thereby lowering investors’ expectations for the future path of the federal funds rate and putting additional downward pressure on long-term interest rates, particularly in real terms.”

Columbia University professor Michael Woodford delivered a mammoth 97 page paper at the Jackson Hole conference arguing that the Fed should focus on communication strategy directly. His paper, which many folks think may influence Fed policy makers, argued that the Fed should commit to keeping short-term interest rates low for an extended period—even if inflation and other indicators might otherwise call for raising rates. One way to do this would be for the Fed to announce that it was targeting nominal gross domestic product growth and would keep interest rates low until the economy is performing at its full potential.

“The point of a nominal GDP target to Mike [Prof. Woodford] is this: When and if inflation breaks out (which raises nominal GDP) or (let’s hope) real GDP starts growing again, the Fed, following the usual Taylor rule linking interest rates to GDP growth or inflation, would normally raise rates. If the Fed instead changes to a nominal GDP target, then the Fed will not raise rates, until the cumulative inflation or real growth brings us back to the dashed line. Then, and only then, will the Fed raise rates,” according to University of Chicago Booth School of Business professor John Cochrane. (Cochrane says he agrees with 99 percent of the paper.)

Will the Fed Fire up Another Round of Easing?

(AP)

The main obstacle to this approach is one of credibility. The Fed has spent decades building its reputation as an inflation fighter. It’s not at all clear that markets will believe that the Fed would tolerate unexpectedly high inflation shocks—regardless of what the Fed says about its policy. What’s more, the political pressure brought to bear on a Fed that announced it was going to ignore inflation could be enormous—and perhaps even result in a challenge to the Fed’s independence.

At the very least, we’d be in unknown territory. Historical models predicting Fed actions would forecast one thing, while untested models based on the Fed’s statements would say another. Politicians worried about the Fed “debasing the dollar” would be hoisting pitchforks on Capitol Hill. This uncertainty alone could undermine the intended effects of NGDP targeting.

Woodford’s paper argues that NGDP targeting would work best—if at all—if coordinated with fiscal policy. That is, the Treasury would have to borrow money, Congress would have to spend it, and the Fed would buy the debt. That kind of coordination seems—at least, prior to Election Day—very unlikely. Certainly that’s not what we’ll hear about when the Fed meets next.

So the Fed’s options include providing stronger forward guidance about the direction of policy rates, extending the MEP-Twist well into next year, and buying mortgage-backed securities. Since the latter two options will likely have limited direct effect, I suspect we’ll see some combination of all three programs aimed at effectively communicating a Fed commitment to stimulating the economy.

–

RELATED:

© 2012 CNBC.com, John Carney

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Comments (61)

1 2
  • DisposableWorker
    Posted on September 8, 2012 at 12:37am

    Does your mother know what you do for a living?

    Report this comment

    DisposableWorker  
    • Detroit paperboy
      Posted on September 8, 2012 at 9:17am

      Why do you think gas is so expensive ? There’s more oil on the market than ever before,,,,it’s cuz the dollar is worthless and global oil is pegged to the dollar so they need more worthless dollars per barrel…..we are so screwed with these Harvard morons running things..”.”.”.

      Report this comment

      Detroit paperboy  
    • The-Obama-Romney-Ticket
      Posted on September 8, 2012 at 4:02pm

      “What Will The Fed Do?”

      Easy one. Three words. NEW. WORLD. ORDER.
      Hope you like the number 6. ;)

      Report this comment

      The-Obama-Romney-Ticket  
    • black9897
      Posted on September 8, 2012 at 4:58pm

      Unless we start living free and stop filing they will continue to steal our money. Not sure I could look at myself in the mirror if I violently stole money from others as my living.

      Report this comment

      black9897  
  • Cruelnunusual
    Posted on September 8, 2012 at 12:10am

    Who is depositing the trillions that the Fed lends us, the Martians?

    Report this comment

    Cruelnunusual  
  • Individualism
    Posted on September 7, 2012 at 11:10pm

    Qe3

    Report this comment

    Individualism  
  • hades3
    Posted on September 7, 2012 at 11:01pm

    The Fed has put itself in such a position it only has one option. That is to increase the money printing presses to the speed of light. It is like a runaway train, if it stops, infaltion will reduce the dollar to pennies as far as value is concerned, if it continues, the same will happen. The day of reckoning for our economy is fast approaching. Why do you think Federal agencies are purchasing so many hollow point bullets ? Only idiots believe the story that originally was told, that the purchase was a clerical error, When that didn’t sell, we were told the Social Security Administration police force purchased the ammo, because they need it to fight fraud. Yeah, right !

    Report this comment

    hades3  
  • trueblueday
    Posted on September 7, 2012 at 10:32pm

    Amazes me how easily a country can be run by fools – a few over the many, and how easily we just let it happen, without consequence. As if they have the answers. What a complete and utter sham. Might as well go back to sleep. Tomorrow…different day, same cr*p.

    Report this comment

    trueblueday  
  • Bohump
    Posted on September 7, 2012 at 10:17pm

    They will print more Money, .. Spend It, … And then Blame Mr. BUSH .

    Report this comment

    Bohump  
  • affinity
    Posted on September 7, 2012 at 9:36pm

    Since there’s already too much debt based currency and too little real property in the world I’m figuring the Fed Chairman and his power broker friends (the controllers) are probably preparing to move underground. Be prepared.

    Report this comment

    affinity  
  • Yakov-Yurovsky
    Posted on September 7, 2012 at 8:41pm

    I pledge allegiance to the Banksters of the Internationale, and to the monetary system for which they stand, all nations, in interest slavery, with high taxation and austerity for all!

    Its one thing to not let the flag hit the ground, but these guys are going to bury it! Now Audi† the F-ing Fed!

    Report this comment

    Yakov-Yurovsky  
  • 762x51
    Posted on September 7, 2012 at 8:20pm

    The Fed will continue to collapse the value of our currency, that is a central piece of the destroy America plan that these criminals are working on.

    The criminals Bernanke, Geithner and Obama should be in Gitmo.

    The Fed has run out if bullets boys and girls. They have no more arrows in their quiver, only inflating the currency, i.e., QE III, QE IV, QE V, etc. Hyperinflation is a given now, if you are not prepared, you are already dead.

    Report this comment

    762x51  
    • smokeysmoke
      Posted on September 7, 2012 at 8:49pm

      we do realize that when you decrease the value of money it is a tax for the middle class… not only are you decreasing the holdings that people have in cash, you are increasing the price of goods at market, and peoples pay/salaries are not worth the same since you get paid in devalued dollars… THIS IS A DECREASE ON THE STANDARD OF LIVING OF THE AMERICAN PEOPLE…. when people are paid with devalued dollars… AND the price of goods are more expensive; employers are FORCED TO CHOOSE between paying their employees more to make up for the LOWER STANDARD OF LIVING, or allowing the pay of their jobs become uncompetitive… SO massive spending is a long term tax on the MIDDLE CLASS, beucase employers charge more for their goods to pay their employees more, so they can have a living wage… CUT THE SPENDING, AND QUIT STAGNATING THE STANDARD OF LIVING

      Report this comment

      smokeysmoke  
  • JohnQTaxpayer
    Posted on September 7, 2012 at 7:15pm

    It will be written in the history books

    America committed suicide in the name of helping those people whom contributed the least to the advancement of society

    In the process the American government martyred; prosperity, intellect, indivualism, greatness and morals to the poor

    America chose bankruptcy and anarchy over responsibility

    Report this comment

    JohnQTaxpayer  
    • The_Jerk
      Posted on September 7, 2012 at 7:20pm

      It’s the disease of the successful. Once successful, they stop doing that which made them successful. This leads to the great fall.

      Report this comment

      The_Jerk  
  • garbagecanlogic
    Posted on September 7, 2012 at 7:13pm

    This guy has to be told daily which end to blow and when to wipe. Bring someone in who knows what they are doing. Anyone – even myself knows how to print money.

    Praise Be To Obama. Psalm 109:8

    The U.S. Out Of The U.N.
    The U.N. Out Of The U.S.

    Report this comment

    garbagecanlogic  
    • justangry
      Posted on September 7, 2012 at 7:59pm

      I believe Dr. Paul when he says that printing money is the only tool they have at their disposal. Bringing someone else isn’t going to fix the problems. It’s not the leadership, but the Federal Reserve itself.

      Report this comment

      justangry  
  • U.N.hater
    Posted on September 7, 2012 at 6:58pm

    Treason. Your S.S. card is not a retiement card it is a debters card. Look it up.. You are nothing more than a debter paying off a debt. Managed by guess who? This is why i say vote’ing will change NOTHING!

    Report this comment

    U.N.hater  
    • The_Jerk
      Posted on September 7, 2012 at 7:06pm

      Real change involves ending the Fed. Why should private citizens, many not of this nation, be permitted to steal our wealth? We’re fools. Our children suffer the consequences of our foolishness.

      Report this comment

      The_Jerk  
  • grams09
    Posted on September 7, 2012 at 6:54pm

    I think the plan is to prop up the government until after the election.

    Report this comment

    grams09  
    • The_Jerk
      Posted on September 7, 2012 at 7:04pm

      No it is not. Who occupies the White House changes nothing, when others control the currency. The Jewish banker, Rothschild, said it best: ““Give me control over a nation‘s currency and I don’t care who makes the laws.”

      The Jewish banker, Bernanke, lives the prediction.

      Report this comment

      The_Jerk  
  • Darmok and Jalad at Tanagra
    Posted on September 7, 2012 at 6:51pm

    Twas the night before QE3 and all through the Fed, not a money changer was stirring not even Uncle Ben.
    When suddenly with a clatter, the Fed did errupt, and in came a spirit, all dressed up in a cloak.
    Why have you done this to the Republic we built, Jefferson, Franklin even Hamilton though he was killed by Burr.
    You keep printing money in which our God has laid trust, you do this with malice and bad intent to all of us.
    Why do you spit at the People and rob their childrens futures? Why must you sell their souls like a drunken sailor does booze purchase?
    Uncle Ben sighed, took a long sip of scotch, looked up at the spirit and then he did scoff, “you think you built a country to last, you built a country, but Wilson let it pass. This is a plan that was laid a century ago, one no one can stop, even if they did know.”
    We will have our one world govt., not of the people, but of barons and lords, who shall rule all of the Sheeple.
    So go back to the grave, spin if you must, your dream is no good, it is full of rust.
    The Spirit took pause, and look Ben in the eye, and asked if people still have guns and most of their rights.
    Ben answered, Yes, but not for long, come Nov. 6, that will all be gone.
    The Spirit, then stated, I seen men like you before, at Philly, at Vally Forge, and the last was at Yorktown, all of you naysayers were sent a packing, back to your homes, back to your king and your lackeys.
    This country still lives, and has one more chance, Nov 6, choose w

    Report this comment

    Darmok and Jalad at Tanagra  
  • simply one voice
    Posted on September 7, 2012 at 6:46pm

    The Federal Reserve System with its Reserve Board Chairman Ben Bernanke IMHO is the same as the Electoral College. It’s a rigged criminal ponzi scheme where your opinion or vote doesn’t mean anything, really. I will vote the entire Republican ticket here in AZ, in November to save my sanity and, my above statement, daily, really burns my “A”.

    Report this comment

    simply one voice  
    • babylonvi
      Posted on September 8, 2012 at 12:22am

      Obviously, your education on the founding of this great republic and the Constitution were lacking Sir. There were and still are good reasons for the electoral college. The purpose, just as the purpose of the Senate, was to give small states a slight ‘handicap’ with respect to the large states. As it is, a few large liberal states could elect a Liberal President even if a large margin of state voted otherwise. In fact, the constitution would never have been ratified in the first place if it were not for these elements that help prevent a tyranny by the majority. I believe elements such as this have proven to be more important than ever as we have all seen how easy it is to be brought from capitalism to Marxism in four years by a fact talking charismatic con man who is communist to the core.

      Report this comment

      babylonvi  
  • team1blazer
    Posted on September 7, 2012 at 6:45pm

    Both of the pictures accompanying this article show Obummer and Bernanke….I’d like to see both of these treasonous traitors in another picture….hanging from ropes.

    Report this comment

    team1blazer  
    • grams09
      Posted on September 7, 2012 at 6:52pm

      Oh. Oh. The FBI will be knocking on your door. Stop and think before you post.

      Report this comment

      grams09  
  • 502_eagle
    Posted on September 7, 2012 at 6:44pm

    Awww Ben just print more money, $4 gas is no biggie.

    Report this comment

    502_eagle  
  • Just_Bubba
    Posted on September 7, 2012 at 6:41pm

    Back door printing and buying our own debt is the only thing they know. Once again we are in the hands of very stupid people. No learning anything new for them because they know ALL the answers before the question is asked. It’s called blind stupidity.
    Once they collapse the system it will be clear sailing for all of us who are prepared and free and clear. It will be poor houses for all of the Encinominals out there. I will again quit working to starve them of my tax $ and become part of the underground economy which will form under their very noses. Precious metals and skills will be the only valued currency while things settle out. Greenbacks will be toilet paper before they are done here.
    Good luck to those who believe in this administartion’s solutions. Starving should be great fun.

    Report this comment

    Just_Bubba  
    • The_Jerk
      Posted on September 7, 2012 at 6:58pm

      They are not stupid. We are stupid. They are lining their pockets with our money. They are taking your family’s future. These are the money changers of the Bible. Both worked in currency and currency exchange.

      Report this comment

      The_Jerk  
    • drs1969
      Posted on September 7, 2012 at 11:50pm

      Just like the USSR, the economy is being forced ‘underground’. Ben Shalom Bernanke ,Tax-Collector for the Embezzlement/Welfare State, or Parasite.

      Report this comment

      drs1969  
  • CatB
    Posted on September 7, 2012 at 6:35pm

    Federal Reserve Board Chairman Ben Bernanke needs to be brought up on charges .. he lied to Congress saying he would NOT monetize the debt and that is EXACTLY what he is doing .. Obama’s bidding to destroy the dollar.

    Report this comment

    CatB  
  • MrKnowItAll
    Posted on September 7, 2012 at 6:33pm

    I still remember finding a nickel or two in the coin return of the newspaper boxes that used to be everywhere. I still remember I was rich with that nickel or two. All the stuff you could buy with that one nickel was unbelievable, living now in 2012.

    Report this comment

    MrKnowItAll  
  • hi
    Posted on September 7, 2012 at 6:33pm

    How about “Laissez-faire”
    and an audit?

    Report this comment

    hi  
  • The_Jerk
    Posted on September 7, 2012 at 6:27pm

    The Fed will do what’s best for its shareholders, not the American people. It’s time people begin to understand why their wealth is disappearing, and why their kids will have less than they.

    Report this comment

    The_Jerk  
    • Individualism
      Posted on September 7, 2012 at 8:36pm

      yeah history repeats itself again just look at Germany in the early 1900′s to know whats up.

      Report this comment

      Individualism  
  • soybomb315_II
    Posted on September 7, 2012 at 6:27pm

    Yay! More free money

    Report this comment

    soybomb315_II  
  • Larry E
    Posted on September 7, 2012 at 6:26pm

    Whatever the fed does it’s likely to be something that will further screw up the economy if that’s even possible.

    Report this comment

    Larry E  
  • Zipit
    Posted on September 7, 2012 at 6:24pm

    What will the FED do? Screw us again!!!!

    Report this comment

    Zipit  
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