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

Jaclyn Giovis Nov 2, 2010

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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