The Federal Reserve opened a new chapter Thursday in its efforts to accelerate the economic recovery, saying that it would expand its holdings of mortgage-backed securities, and potentially undertake other new policies, until unemployment drops sufficiently or inflation rises too fast.
The Fed said that it would add $23 billion of mortgage bonds to its portfolio by the end of September and then announce its plans for October as part of a new process that aims to prioritize the Fed’s economic objectives.
The Fed also said, in a statement following a meeting of its policy-making committee, that it now expects to hold short-term interest rates near zero until at least mid-2015, extending the forecast it made in January by about half a year.
The statement said that the economy had continued to expand “at a moderate pace,” but that the Fed had concluded “growth might not be strong enough to generate sustained improvement in labor market conditions.”
That has been true for months, perhaps years, but implicit in the statement was the Fed’s conclusion that the situation was no longer acceptable. Eleven members of the committee voted for the action; Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, was the lone dissenter.
The Fed said that its actions “should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.”
On Wall Street, traders welcomed the moves. The benchmark Standard & Poor’s 500-share index was up 0.9 percent, or 12.30 points, to 1,448.86 at midday, rising further as investors had more time to digest the news.
The Fed’s plan went further than many investors had expected by providing an open-ended commitment. But stocks have been rising in recent weeks, partly in anticipation of the Fed taking more measures to support the economy.
“There weren’t many more accommodative options the Fed could have gone with,” said Dan Greenhaus, the chief global strategist at BTIG, an institutional broker.
The scale of the new effort is significantly smaller than the Fed’s previous rounds of asset purchases. The Fed purchased about $100 billion in securities each month during those campaigns. It said Thursday that it would target a rate of about $40 billion a month during the current campaign, although unlike those earlier efforts, the volume is now subject to adjustment.
The new purchases will mark the first time in more than two years that the Fed has expanded its holdings of mortgage bonds. That decision reflects the Fed’s view that the housing market still needs help, and that lower rates on mortgage loans could provide significant benefits for the broader economy.
Seeking to increase the impact of its new policies, the Fed also said Thursday that “a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.”
The language was intended to make clear that this latest intensification does not solely reflect the Fed’s increased concern about the economy, but also reflects an increased determination to make a more forceful response. It suggests that the Fed is willing to tolerate somewhat higher inflation later to encourage stronger recovery in the coming months, something it once insisted was unthinkable but has gradually come to consider a necessity in order to revive the economy.
The Fed had given unusually clear indications in recent weeks that it was ready to act. An account of its last meeting, published in mid-August, suggested action was imminent unless the economy showed “substantial and sustainable” improvement.
A few weeks later, Mr. Bernanke spoke of his “grave concern” about the high rate of unemployment and said that in his judgment, the likely benefits of additional action outweighed the potential costs. A number of longtime observers of the central bank said they could not recall a Fed chairman using stronger language.
Since then, the economy has shown little evidence of substantial improvement. The government estimated last week that employers added only 96,000 jobs in August, and other economic indicators have been similarly lackluster.
Mr. Greenhaus, the BTIG brokerage strategist, said that he expected the Fed’s moves to help investors more than they will help the real economy.
“A lot of what ails the U.S. economy is not entirely fixable by monetary policy,” said Mr. Greenhaus. “Another easing program is only one part of what might be necessary to get the U.S. economy out of the rut in which finds itself.”
The Fed has amassed a portfolio of more than $2 trillion in Treasury securities and mortgage bonds in its effort to reduce borrowing costs for businesses and consumers and to push private money into riskier investments. Interest rates on a broad range of loans have fallen to some of the lowest levels in history, but Fed officials said that further cuts were both possible and desirable.
The Fed is also trying to cut borrowing costs by convincing investors that short-term rates will remain low for longer than they currently expect. The Fed has held short-term rates near zero since late 2008, and it said in January that it intended to keep rates near zero through 2014. Extending the deadline – or replacing it with a horizon tied to better economic data – could also reduce borrowing costs.
The political climate has complicated the Fed’s efforts. Republicans including Mitt Romney, the party’s presidential nominee, have argued against new action. Mr. Romney has promised to replace Mr. Bernanke, and Republicans are seeking to impose new limits on the Fed’s management of monetary policy.
Fed officials insist that they do not consider politics in making their decisions, and history shows that the central bank often has acted during presidential campaigns – it has announced policy changes in September or October during 10 of the last 15 presidential election years, according to research by Credit Suisse.
Moreover, the political situation also has provided a motivation for the Fed to act. The nation’s fiscal policy – including the tax increases and spending cuts scheduled to take effect next year – increasingly looms as the largest threat to growth, many experts say. Fed officials have said that it could tip the economy back into recession, and Mr. Bernanke has repeatedly urged Congress to dismantle this “fiscal cliff.” Some Fed officials have argued that the central bank should seek to strengthen the economy as much as possible in the meantime to cushion the potential shock.
The Fed has struggled to define its role over the last three years. Its big and unprecedented actions helped to arrest the 2008 financial crisis, economists maintain. But as the economy has settled between crisis and prosperity, Fed officials have become divided over their ability and responsibility to do more.
Mr. Bernanke has presided over a gradual intensification of the central bank’s stimulus campaign, but the central bank has repeatedly underestimated the depth of the nation’s economic problems, and the unemployment rate has remained stubbornly high. The Fed has said its current policies would not reduce unemployment to normal levels for years to come.
Some Fed officials, like Charles Evans, president of the Federal Reserve Bank of Chicago, have argued for more than a year that the Fed should significantly increase its efforts to stimulate growth. Others, like Mr. Lacker, president of the Federal Reserve Bank of Richmond, say the Fed already has done too much.
There is broad disagreement among economists about the effects of the Fed’s expansion of its balance sheet. The Fed’s own research shows it may have raised economic output by 3 percent and created more than 2 million jobs. Most independent analyses have reached more modest conclusions, and some experts argue that there is little evidence of any meaningful economic impact.
Experts also disagree about the likely impact of additional purchases. Mr. Bernanke said last month in Jackson Hole, Wyo., that he was confident such a program would stimulate the economy. Significantly, he also said that he had concluded the likely benefits of such a program would outweigh the potential costs.
Many outside economists share Mr. Bernanke’s conclusion that the Fed retains considerable power to bolster the economy. However, some economists argue that the Fed has exhausted its power or that the costs now outweigh the benefits.
Economists also debate the value of the Fed’s statements about the future level of short-term interest rates. After the most recent statement, in January, Mr. Bernanke made clear that the Fed was making a prediction, not a promise – it was simply saying that rates would remain low if, as it expected, the economy remained weak.
But such a prediction is basically just a different way of expressing the Fed’s economic forecast, and some research shows that such statements have little impact. Many economists say the Fed should say instead that it will keep rates near zero until certain economic thresholds are reached.
Investors may still view such promises with skepticism however, because Mr. Bernanke’s term as Fed chairman ends in January 2014.