Fed Reserve Chairman Ben Bernanke announced during Thursday’s Fed meeting that the Fed will engage in a third round of quantitative easing (QE3) to help improve the stagnant U.S. unemployment picture and stimulate the economy.
“The employment situation, however, remains a grave concern. While the economy appears to be on a path of moderate recovery it isn’t growing fast enough to make significant progress reducing the unemployment rate” Bernanke said to reporters on Thursday.
Under QE3 program the Fed will pump 40 billion into the U.S. economy each month until the employment picture improves.
The third quantitative easing program works by the central bank purchasing large amounts of mortgage-backed securities (bonds) to drive down interest rates and boost the U.S. economy.
The Fed’s emphasis on mortgage-backed bonds is a shift away from purchasing Treasuries which occurred during QE 2 when the Federal Reserve purchased about $770 billion in Treasury securities.
After QE2 ended, the Fed engaged in monetary action commonly known as “Operation Twist” whereby the Fed purchases $400 billion in longer maturity Treasury bonds to replace $400 billion in shorter-term Treasury securities. The action helped to lower long term interest rates or borrowing costs.
The first “Operation Twist” program began in September 2011 and was extended a second time in June 2012 after the Fed announced they would continue the program of buying Treasuries with maturities of six to 30 years worth $267 billion.
The Fed’s first stimulus program in 2009 was centered on purchases of mortgage-backed bonds, similar to the newly announced QE3.
Currently, banks earn a mere .25% in interest to keep their money parked at the Federal Reserve.
By engaging in large purchases of mortgage backed bonds through QE3, the Fed pays for its purchases by crediting the accounts of banks from which it buys the bonds.
As the new Fed dollars grows larger in their Fed accounts, banks may likely become more willing to take risks and lend to companies and Americans rather than collect .25% of interest at the Federal Reserve.
After banks extend their lending programs, the net effect is more liquidity in the market which can help to stimulate the overall economy and create better economic conditions for companies to expand their core business operations and potentially hire new workers.
During quantitative easing program such as QE3, the U.S. dollar typically weakens, making it easier for U.S. companies to sell American products in the international market which also helps to boost the U.S. economy.
The Fed’s released statement on Thursday suggests that there are growing concerns about the health of the U.S. economy.
“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 Fed wrote.
Bernanke said in his Thursday news conference that the lower rates on mortgage bonds could allow banks to offer lower home loan rates which may create more economic activity.
More Accommodative Actions To Come
The Fed announced that they plan to maintain a accommodative approach towards monetary policy even after the economic recovery takes hold.
“To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.”
The Fed plans to “keep the target range for the federal funds rate at 0 to .25% and currently anticipates that exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015.”