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Federal Reserve will buy $600 billion in long-term government bonds

Federal Reserve Chairman Ben Bernanke speaks during a House Financial Services Committee hearing on Capitol Hill in Washington, D.C.

Federal Reserve Chairman Ben Bernanke on Thursday defended his latest strategy to revive the U.S. economy after some analysts raised questions over whether his plan is too risky and unproven to generate positive results.

"Although asset purchases are relatively unfamiliar as a tool of monetary policy, some concerns about this approach are overstated," Bernanke said, in an opinion column published Thursday in The Washington Post.

It's not exactly "printing money," but the Fed did announce it planned to inject new money into the U.S. economy by purchasing $600 billion in long term government bonds.

Bond purchases are important to economic activity - they can force interest rates down on mortgages and other loans like on cars. The economic strategy, called quantitative easing, then suggests that would create growth for businesses, who would start hiring to meet that demand.

Many analysts have raised concerns that the bond-buying strategy could force commodity prices to rise, ushering in inflation and reducing consumer confidence in the Fed's ability to set monetary policy.

"We have made all necessary preparations, and we are confident that we have the tools to unwind these policies at the appropriate time," Bernanke wrote, adding that the Fed "will take all measures necessary to keep inflation low and stable."

The long term success or failure of the Fed's quantitative easing policy is not determined by the amount of money that's pumped into the economy but rather on the effect it has on the psychology of the market, said Dominic Sword, business of economics professor at the Henley Business School in the United Kingdom.

"It's really about whether businesses feel able to take advantage of the liquidity its created and start to invest and whether members of the public, consumers, feel that it's a good time to get back out and start spending," Sword said.

The Fed's action Wednesday marks the second time it's tried the easing approach. Following the market's crash, the central bank's responses was more dramatic - - reducing short-term interest rates to nearly zero. It also purchased more than a trillion dollars worth of Treasury securities and U.S.-backed mortgage-related securities. This measure helped to lower longer-term interest rates.

"Certainly, the experience of printing money the first time around did go a long way to stabilizing the banking sector, stabilizing financial markets, and you could argue probably averted the American economy from tipping into a depression," said Neil MacKinnon, chief economist of the VTB Capital Group.

But the U.S.'s economic recovery has been "pretty anemic" compared to historical recoveries, and the future is still uncertain, he added.

"Going forward, the printing of more money may have less effect" than it did the first time, MacKinnon said.

Today, the national unemployment rate is 9.6 percent, with many of those people out of work for six months or more. The latest employment figures are due out Friday.

"The Federal Reserve cannot solve all the economy's problems on its own," Bernanke said. "That will take time and the combined efforts of many parties, including the central bank, Congress, the administration, regulators and the private sector."

Global markets began to react to the Fed's announcement Wednesday.

Marketplace reporter Stephen Beard contributed to this report.

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Consider: The money supply has regularly been flowing out of the US as a result of our ongoing trade deficit and dollars are being stockpiled in foreign central banks who are attempting to manipulate their currencies. That means there could be a legitimate a shortage of liquidity in the domestic economy, in which case this strategy theoreticlly could work - UNTIL the foreign banks start dumping their dollars.

To Patrick: Waiting until after the election may have been deliberate. Perhaps they did not want to be accused of playing politics?

The Federal Reserve is planning an additional $ 600 billion of quantitative
easing to further stimulate the economy.[1] The effect of this program will be
substantially reduced if the Fed doesn't also use moral (or other) suasion to
induce banks to make these windfall benefits trickle down to consumers.

The 5 year fixed to LIBOR swap rate is 1.43 %. [2]
The 11th district cost of funds is 1.66 %. [3]

The chargeoff rate for Fitch's prime credit card index (an index of general purpose
credit card portoflios) is 9.22 % per year. [4]

Nevertheless, its gross yield is 21.92 % per year. [5]

This means that banks are receiving approximately 11 percent more per year
on their average credit card debt than they are losing in chargeoffs plus cost of funds.
That's 1100 basis points. This is abusive - and acts to dampen the economic recovery.

Hopefully, the consumer financial protection bureau can look into this issue when
it comes online. Consumers are often unable to effectively negotiate interest
rates with their banks. Nevertheless, if the Federal Reserve actually wants
its QE to work - it should insist that any banks benefitting from its largess
cap their spread (gross yield less chargeoffs and bank COF) at 500 basis points.
(This can be done post-hoc if banks complain about uncertainty in these rates).
500 basis points is more than sufficient to cover servicing and a generous profit.

Lower consumer interest rates will stimulate the economy and reduce
chargeoffs (as lower bank interest rates have helped the banks).
An otherwise healthy entity that has its interest rate jacked up is often unnecessarily
driven to default. This issue is at the core of why consumers feel the bank bailout
shortchanged them. The Fed should take an active role in preventing
abusive spreads if it wants its QE to do anything other than just provide a
windfall profit for large banks.

References :

[1] http://www.bbc.co.uk/news/business-11678022
[2] http://www.federalreserve.gov/releases/h15/data/Monthly/H15_SWAPS_Y5.txt (10/2010 rate)
[3] http://www.bankrate.com/rates/interest-rates/11th-district-cost-of-funds... (10/27/2010 rate)
[4] http://online.wsj.com/article/BT-CO-20101102-713344.html
[5] http://www.pymnts.com/fitch-us-credit-card-defaults-drop-to-18-month-low...

I have a question about the timing of this - AFTER the elections. Was that deliberate by the Fed? If they had done this earlier, might it have had an effect on the election results? Thanks

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