US Fed expands QE3, sets policy thresholds to spur recovery

After its final policy meeting of this year, the US Federal Reserve on Wednesday announced to continue pumping money into the economy by buying assets and hold its short-term rate near zero until the unemployment rate drops below 6.5 percent, an aggressive move to stimulate economic growth and job creation.



But some economists cautioned that a long-period of historically-low interest rate since the end of 2008 and large asset-buying programs have underpriced credit and increased risk taking, fueling asset bubbles in the global stock and commodity markets, but could not provide a strong boost to US business hiring and economic recovery.



MODERATE GROWTH OUTLOOK



US economic activity and employment have continued to expand at a "moderate pace" in recent months, despite weather-related disruptions. Although the unemployment rate has declined since the summer, it remains elevated, stated top Fed policymakers.



Household spending has continued to advance, and the housing sector has shown further signs of improvement, but growth in business fixed investment has slowed, the Fed said in a statement issued after a two-day policy meeting of the Federal Open Market Committee (FOMC), the Fed's powerful interest-rate setting panel.



"The Committee remains concerned that, without sufficient policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions," added the Fed.



The FOMC participants on Wednesday slightly lowered their outlook for US economic growth next year, predicting US economy to expand by 2.3 percent to 3.0 percent in 2013, as against the range of 2.5 percent to 3.0 percent projected in September.



At a a press conference after the FOMC meeting, US Federal Reserve Chairman Ben Bernanke warned that the uncertainty caused by the negotiation between Democrats and Republicans over the " fiscal cliff" was hurting US business confidence and economic growth.







CLEAR THRESHOLDS



In an unprecedented move, the Fed decided to keep the target range for the federal funds rate at zero to 0.25 percent, and anticipates that this exceptionally low short-term rate will be appropriate as long as the unemployment rate remains above 6.5 percent and inflation is projected to be no more than 2.5 percent "between one and two years ahead."



This is the first time that the Fed has set explicit unemployment and price thresholds for its monetary policy guidance to better explain its policy intentions to the market.



The new step was to make monetary policy "more transparent and predictable to the public," Bernanke told reporters.



Fed policymakers on Wednesday forecast the US unemployment rate to be no lower than 7.4 percent in 2013 and to be higher than 6.8 percent by the end of 2014, which means that the central bank might adopt the ultra-loose monetary policy through 2014.



EXPANDING QE3



The Fed announced that it will purchase longer-term US government debt at a pace of 45 billion US dollars per month starting in January, a move to expand its third-round quantitative easing program, also known as the QE3.



The latest step came ahead of the expiration at the end of this month of "Operation Twist," in which the Fed sells 45 billion dollars of short-term Treasuries and replaces them with the same amount of longer-term government debt.



The current Operation Twist policy has to expire whether Fed policymakers like it or not, because the Fed will run out of short- dated bonds to sell, David Semmens, a senior economist of Standard Chartered Bank, said in a Wednesday research report.



The central bank in September started to buy agency mortgage- backed securities (MBS) at a pace of 40 billion US dollars per month to bolster recovery of the housing market, the so-called QE3.



The new Treasuries-buying program unveiled on Wednesday will be funded by creating new money, further expanding the Fed's 2.9 trillion dollars balance sheet. Starting in January, the total monthly increase in the Fed's balance sheet will pick up speed from 40 billion dollars to 85 billion dollars to drive down long- term borrowing costs.



Since the onset of the financial crisis, the Fed has completed two rounds of quantitative easing programs, dubbed as QE1 and QE2. It has bought more than 2 trillion dollars of US government debt, agency MBS and other assets. These programs have attracted sharp criticism both at home and abroad.



"The Fed is distorting one set of financial markets when trying to fix another set," Philip Suttle, Chief Economist of the Institute of International Finance (IIF), said in a recent interview.



The Fed's balance sheet expansion move will "stimulate risk appetite, as well as capital flows to emerging markets," contended Semmens.



The huge liquidity from central banks is creating another round of liquidity excess and risk-taking activities, echoed Suttle, adding what the United States really needs is triggering easier lending conditions for the private sector and home buyers to bolster economic growth.





