The Federal Reserve, Its Mandates, and QE3

As discussed earlier on this blog, the Federal Reserve has initiated its latest stimulus package dubbed QE3.  Because the Fed is in the news so much these days it might be wise to review what the Fed’s mandates are and whether or not this latest round of easing is consistent with those mandates.

 

The United States Congress established statutory objectives for the Federal Reserve (in the Federal Reserve Act) in order to guide their process in determining monetary policy.  Remember, the Fed is charged with establishing and directing monetary policy based on the mandates established by Congress while fiscal policy is the tax and spending policies established by the federal government.  Our focus here is on the monetary policies of the United States which have at their core three objectives:  Maximum employment, stable prices, and moderate long-term interest rates.  To achieve its’ goals, the Federal Reserve takes action such as buying or selling securities, increasing or decreasing interest rates, and increasing or decreasing reserve requirements for member banks. 

 

While all three objectives are somewhat related, perhaps interest rate policies and inflation policies are most closely correlated.  Earlier this year, the Fed issued a statement in which they noted that their longer-term goal for inflation was 2 percent.  They felt that by clearly stating this goal they were helping to foster both price stability and moderate long-term interest rates.  They also indicated that this would also help the Fed in its process of seeking maximum employment rates.  In general, inflation has stayed at or near the Fed’s target and certainly longer-term interest rates have stayed at or below a “moderate” level.  The Fed has not defined what “moderate” means but they have a stated desire to keep shorter term interest rates at or near zero percent until 2015 at the earliest which should keep longer-term rates relatively stable as well.

 

The remaining mandate, maximum employment, has been both evolving over time and a much tougher goal to reach.  According to the Federal Reserve’s website “The maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the job market.  These factors may change over time and may not be directly measurableAs a result, the FOMC does not specify a fixed goal for maximum employment…”  (Bolding and italics are mine).  Even though the Fed does not specify a goal for maximum employment, it has discussed different levels.  Recently, that level was within a range of 5.2 to 6.0 percent which is about the same as last year but the Fed notes that the rate is “substantially higher than the corresponding interval several years earlier.”  Based on these comments, and the current financial stress that the economy is feeling, it is easy to see why the Fed has raised the target unemployment rate.  It is also easy to see the difficulty that the Fed is having in reducing the rate.

 

The Fed has announced that it is going to purchase $40 billion in mortgage backed securities each month until the labor markets show significant improvement.  The Fed has left the door open for this program to go on indefinitely.  They also announced that Operation Twist will continue and that they intend to keep short-term rates near zero until sometime in 2015 at the earliest.  The intention is to get the economy moving and thereby create jobs.  It remains to be seen if this latest effort will work or not but it has given additional life to the equity markets.

 

Let us know what you think…will QE3 work?  Will inflation increase?  Due to the fact that Madison and Dane County have relatively low levels of unemployment, will there be much of an impact locally?

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