One thing is for sure. Mr. Bernanke’s announcement yesterday is the most extraordinary to come out of the Fed since the all-time previous: Paul Volcker on Columbus Day weekend 1979 said the Fed would allow interest rates to rise as high as necessary to defeat inflation.
As today’s problems are the polar opposite of 1979, and raising rates had long been the accepted and effective remedy for inflation, and Mr. Volcker’s policies succeeded in solving the problem, it is difficult further to compare these two moments.
From yesterday’s announcement by the Federal Open Market Committee: "If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases… until such improvement is achieved in a context of price stability."
The committee "expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economy strengthens."
Other for-sure things: mortgage rates fell .25 percent instantly on the Fed’s promise to buy about 65 percent of mortgage paper created through the end of the year, but this morning at retail gave up more than half of that gain (partly profiteering by giant banks with no competition).
The 10-year Treasury has had a bad month, bad week and bad overnight, yields rising from 1.55 percent to 1.87 percent (the Fed will not now increase its long-Treasury buys). The stock market in Dow terms has risen 250 points but looks gassy, trying to square Fed action with the reality of the need for it (the Fed did not take its most dramatic action ever because things are nifty out there).
One more for-sure: the U.S. economy is NOT entering recession. Gasoline prices or no, retail sales rose 0.9 percent in August. The small-biz surveyor National Federation of Independent Business (NFIB) found a small increase in optimism among its members in August, and relative stability all through summer.
Ominous, but not a killer, and reflecting weakness overseas, industrial production fell 1.2 percent in August, the most since 2009. Overall fragility, but not the self-reinforcing downward spiral marking recession, or close to it.
The unknowns are as dramatic as the announcement.
Why now? Why 50 days before a presidential election? Why not wait until the week after?
Mr. Bernanke only once before has acted in haste, the short-stroke cuts in Fed funds in January 2008, when it seemed one morning while trimming his beard, the face of Great Depression II appeared beside him in his mirror. As nothing is immediately pressing in the U.S. economy, perhaps his inside knowledge of Europe and China indicate things are rather worse over there, and the U.S. engine must pull the world, and quickly?
This new QE3 structure runs only to the end of 2012, which dovetails with the fiscal cliff. If we go off, the Fed will have more to do. If it is delayed, less. If it is resolved by austerity, more. If by can-kicking — who can know? All of those eventualities depend of course on the mix of president and Congress elected, and their actions if any.
The sense of urgency may also reflect that Mr. Bernanke’s own time is coming to a close. His term ends in January 2014, which means a replacement nominated within the next 12 months, and rapidly approaching lame-duck status. He could succeed himself, if willing, if either presidential candidate had the wisdom, but I cannot imagine anyone looking forward to Congressional confirmation hearings, no matter who the nominee.
Have no doubt at all… The actions of the Fed since the show stopped in 2007 have been the personal heroism of Mr. Bernanke, the only high officer in U.S. government to rise to the occasion since the show stopped in 2007. And all of the others have failed to find so little as the grace to help him.
The overriding doubt, I am certain shared by the Chairman: will it work? Will it have enough force, the financial system still crippled? All worries of QE-inflation or currency debasement have been badly mistaken, but will they stay so? Will Bernanke have time and support from the next Administration? Congress? Internal revolt at the Fed?
Has this QE experiment been the right thing to do, and to triple-down now? Duh. Lead-pipe cinch.
Ten-year Treasurys have taken out the top of the spike in mid-August. One of the ways that QE could fail: long-term investors leaving the bond market no matter how much of it the Fed buys. Although that is a primary risk facing the European Central Bank, I doubt it here.
The prospects for QE3 began to rise in mid-summer, and the Dow with it, and surged since Bernanke’s Aug. 31 Jackson Hole speech. You may not like the idea of the Fed supporting the stock market, but the main way to prevent a very ugly end to this stagnation is to help assets to rise in value — houses and stocks. The Great Recession crushed household balance sheets, and assets must rise in value for the economy to grow, and to survive the inevitable fiscal discipline ahead.